Trump’s Fed fight seems to be coming from another country

A political leader who demanded questionable policy from the central bank and tested the legal limits to get it – to Martin Redrado, who sits in Argentina, Donald Trump’s stand-off with the Federal Reserve feels strangely familiar.

Redrado was ousted as head of Argentina’s central bank in 2010, after he defied former President Cristina Kirchner’s orders to hand over reserves to help pay national debts.

He successfully fought the court’s decision, but eventually resigned in the face of what he told the BBC was “intolerable” pressure.

Today, the battle is remembered as one of the first warnings of the economic turmoil that later engulfed Argentina, exposing it to high inflation and a currency plunge from which the country is still recovering.

Trump’s fight with the Fed has fueled debate about whether the US may be headed in the same direction.

Since his return to office last year, Trump has accused the chairman of the US central bank, Jerome Powell, of mismanaging the economy and raising debt costs for the government by keeping interest rates high.

But his interventions at the bank were not limited to complaints on social media.

In August, Trump moved to sack of a top policymaker, Lisa Cooka decision that is now being challenged in the Supreme Court.

Then on Sunday, Powell said the Fed is facing a criminal investigation from the Department of Justicerelated to the cost overrun of a property renovation – concerns that Powell dismissed as “excuses”.

Market reaction to the drama has remained muted, which analysts say is a sign that investors expect the bank to continue operating freely.

But that faith will be tested in the coming weeks, when the Supreme Court is due to hear arguments about Cook’s firing and the president is expected to announce his choice to replace Powell, whose term as Fed chair ends in May.

Redrado said he was surprised to see echoes of his own war taking place in the US, which has long been held up as a global model.

“This seems to be a developing market story,” he said.

He is not alone in making the comparison.

“This is what you do in banana republics, not what should happen in the United States of America,” the economist Jason Furman, who leads the Council of Economic Advisers of former President Barack Obama, told the BBC, using a derogatory term often used to describe countries with unstable politics and economies subject to the whims of a ruling class.

In an interview with CNBC, former Fed chair Janet Yellen, who served as Treasury Secretary under Joe Biden, raised a similar specter as she warned against the way Trump wants the Fed to conduct policy. “This is the road to a banana republic,” he said.

Trump remains defiant in the face of calls to limit his interference in the bank, a powerful economy player, with access to vast financial reserves and the ability to influence borrowing costs throughout the economy.

He denied involvement in the criminal investigation, which he said had nothing to do with interest rates, while maintaining his right to express his views.

“I think I did a good job,” he said.

But economists said Trump continued his attacks on economic risk, arguing that hard-earned evidence shows central banks deliver the best results when they act without political pressure.

That consensus emerged from the painful run-in of inflation in the 1970s, including in the US, which led to a wave of global reforms.

Extensive academic research has since linked central bank independence to lower inflation over time.

Experts say elected officials have many incentives to try to use the bank’s power to get an immediate economic boost or satisfy particular constituencies, even if it hurts the economy in the long run.

But while Trump’s pressure on the Fed is unprecedented for the US, the president is not the only head of state to ignore the advice to leave central bankers alone.

In the UK, former Prime Minister Liz Truss attacked the Bank of England, criticizing its independence and accusing it of having too much power.

A study of central banks in 118 countries between 2010 and 2018 found that almost 10% of central banks every year face pressure from political leaders, such as Trump, who want to lower interest rates, making borrowing less expensive and providing a short-term economic boost.

Pressure on central bankers tends to come out in countries with nationalist or populist leaders and is often followed by higher inflation, said economist Carola Binder, a professor at the University of Texas at Austin who conducted the review.

In Turkey, for example, President Recep Tayyip Erdogan is cycling through three central bank leaders in the three years between 2019 and 2021, as he looks for someone to implement his unorthodox view that high interest rates feed inflation.

Inflation rose to 50%, while the bank bowed to his demands, before he agreed to appoint leaders with more moderate views.

Even in countries where central banks resisted intervention, Binder’s research found that inflation tended to rise, albeit to a lesser degree, suggesting that pressure alone could be causing damage.

Binder says he thinks the pressure has led people to doubt the ability of central banks to manage inflation effectively, causing them to expect higher prices in the future – a view that is often self-fulfilling.

Currently, polls suggest that US inflation expectations remain contained, making the likely significance of the current fight more political than economic, Binder said.

However, he warned: “This is a possibility for the US – that it could be inflationary.”

Although the Fed has become a tool of the president, analysts believe the U.S. economy is unlikely to face as severe a downturn as smaller countries such as Argentina and Turkey.

But others say there are signs the fight is having consequences, pointing to an 8% fall in the dollar’s value against a basket of currencies last year.

In the long term, it may be difficult to identify the driver of economic damage – whether it is the loss of central bank independence or other, often related issues, such as the destruction of democracy or the rule of law, said Carolina Garriga, professor of political science at the University of Essex.

But he says that immediate market movements, such as a plunge in the dollar following the announcement of the Fed criminal probe, show investors consider central bank independence an important piece of the puzzle.

“It’s hard to distangle but it’s not hard to distangle when it’s the market’s reaction to an announcement.”

Since the criminal investigation became public, top Wall Street leaders and members of Congress, including some Republicans, have spoken strongly in defense of the Fed.

At the Supreme Court, the justices also indicated that they see the bank differently from other arms of government, where they have allowed Trump’s firing to continue.

Analysts say they think the Fed will be able to maintain confidence in its policies, noting that it sets interest rates through a committee with 12 members, that the president appoints only seven and who each has a long, staggered term.

“There is a bit of concern,” said Jennifer McKeown, chief global economist at Capital Economics. “But there’s no switch here that says faith in US institutions is gone and so we’re in a downward spiral.”

But much of the Fed’s reputation for independence is rooted in convention, rather than legal scheme. on global comparison of central bank independenceas measured by legal features, the herdsman ranks in the bottom third.

Redrado said he remains optimistic that the strength of US institutions will prevail, unlike in Argentina, while warning that Trump is running unnecessary risks.

“President Trump is really defeating himself with this kind of fight,” he said. “He should have known better.”