How Trump's Conflict with the Federal Reserve Threatens Major Central Banks Worldwide?

Sada News - Global central bank governors who gathered at a mountain resort in the U.S. in recent days are beginning to fear that they may be engulfed by the political storm surrounding the Federal Reserve (the U.S. central bank).

President Donald Trump's efforts to reshape the Federal Reserve according to his vision and pressure it to lower interest rates have raised questions about whether the U.S. central bank can maintain its independence and its ability to combat inflation.

Trump is frustrated by the legal protections granted to the leadership of the Federal Reserve and the long terms of the Board of Governors' members, which are designed to keep them in their positions longer than any president.

Trump is exerting intense pressure on the Fed Chair Jerome Powell to resign and is rallying efforts to dismiss another board member, Lisa Cook.

If the world's most powerful central bank succumbs to this pressure or if Trump finds a way to dismiss its members, it would set a dangerous precedent from Europe to Japan, and established standards for the independence of monetary policy could come under renewed attack from local politicians.

Olli Rehn, a policymaker at the European Central Bank from Finland, said on the sidelines of the Federal Reserve's annual symposium in Jackson Hole, Wyoming, "Politically motivated attacks on the Federal Reserve have spiritual implications for the rest of the world, including Europe."

For this reason, Rehn and his colleagues enthusiastically supported Powell in maintaining his position even after he indicated the possibility of lowering interest rates in September. Powell received a warm applause when he took the stage at the conference.

Concerns of Disruption

Discussions with 12 central bank governors from around the world on the sidelines of the symposium revealed that any scenario in which the Federal Reserve sees a threat to its ability to combat inflation due to a loss of independence is a direct threat to its standing and to economic stability in general.

They stated that this is likely to lead to significant disruptions in financial markets, with investors demanding a higher premium for holding U.S. bonds and reassessing the status of U.S. Treasury bonds as the lifeline of the global financial system.

Central banks around the world have already begun to prepare for the repercussions, instructing the banks they oversee to monitor their exposure to the U.S. dollar.

More importantly, a capitulation by the Federal Reserve would end a system that has achieved relative price stability and has persisted at least since former Chair Paul Volcker overcame high inflation 40 years ago.

Since then, other central banks have followed the Federal Reserve's model of political independence and complete focus on their mission, which for most is to keep inflation close to 2%.

German central bank governor and member of the European Central Bank's Governing Council, Joachim Nagel, stated: "This is a reminder that independence should not be taken for granted. We must fulfill our commitments and affirm that independence is a prerequisite for price stability."

A Political Game

Markets have not yet registered deep concerns about the independence of the Federal Reserve, with U.S. stock markets experiencing a strong recovery, and Treasury yields or inflation expectations not rising to indicate a threat to the credibility of the U.S. central bank.

While Trump can appoint a new chair when Powell's term ends in May, he needs more of the seven board members to leave for his appointees to form a majority.

The Federal Reserve network consists of 12 local reserve banks, whose presidents take turns voting on interest rate policy, and the network serves as another balancing weight as local boards view it as a means to distance themselves from Washington's influence.

However, Trump's strained relationship with the Federal Reserve, in a country seen as having established institutional and legal traditions, has made other central bank governors acutely aware of the fragility of their institutions' independence.

Even the European Central Bank, whose independence from the governments of the 20 eurozone countries is recognized by EU treaties, has had to make concerted efforts to prove it.

Right-wing and left-wing parties in countries like Italy, Germany, and France have occasionally criticized the central bank.

Other countries have turned the appointment of central bank governors into a political game.

In Japan, the late Prime Minister Shinzo Abe criticized then-central bank governor Masaaki Shirakawa for not doing enough to combat deflation, and he personally chose Haruhiko Kuroda in 2013 to take over after Shirakawa stepped down weeks before the end of his term.

Kuroda then launched a massive asset purchase program that helped weaken the yen and revive growth, but it raised eyebrows among traditional central bankers by making the Bank of Japan the main creditor to the government.

A Bad Model

Trump has stated that he is "eagerly awaiting" Powell's term ending in May and has publicly begun the process of selecting a successor.

Reuters quoted a source described as knowledgeable about the Bank of Japan's approach, who requested anonymity due to the sensitivity of the matter: "It seems as if Trump has learned from Abe."

In contrast, Trump's actions may encourage governments around the world, especially those with populist leanings, to impose their control over central banks.

This could pave the way for rising inflation rates globally and increased market volatility.

Senior fellow at the Peterson Institute for International Economics and former chief economist at the International Monetary Fund, Maurice Obstfeld, stated: "Control over the Federal Reserve would represent a very bad model for other governments."

He added: "How do you look at what is happening in the United States, which was thought to be a bastion of institutional checks and balances and the rule of law, and not conclude that other countries are easier targets?".

Source: Reuters