The next Fed chair

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You know what? You win some, you lose some. The other day, on this very podcast, we laid out an argument that the super saw away clamour for gold and silver was a speculative frenzy doomed to failure. Well tick. We've had a big reality check there. But then after that we kinda said we thought maybe Scott Bessant, the US Treasury Secretary would be the next chair of the country's central bank. Wrong. Straight after we said that, Kevin Walsh got the nomination.

But hey look, one out of two ain't bad and I don't think listeners are looking for perfection, right? Email to complain if you are robert.armstrong at ft.com. Anyway, today on the show, a little bit on the president's Kevin of Choice. This is Unhedged, the Markets and Finance podcast from the Financial Times and Pushkin. I'm Katie Martin, a markets columnist at FT Towers in London. Finally done with boring, snoring, dry January.

And I'm joined through the magic of the internet by Robert Armstrong, senior executive vice president of the Unhedged Newsletter in New York City, and regrettably, seemingly ruled out early from the job of chair of the Federal Reserve. Rob, I think we now know why you were ruled out because Kevin Walsh, according to Donald Trump, is and I quote.

central casting. Indeed, our colleague Chris Giles says that Walsh was passed over for the job in Trump's first presidency because back then he was too young and too good looking. So Katie, we all have our crosses to bear and mine is mine is devastating good looks. But y but also

I know we've spoken about this on the show before. Trump likes people with great hair. Yeah. That is not my that's not my strength, I'll admit. That is not your strength, but Kevin Walsh does have central casting hair. So Unbelievable hair. Rich, full, lustrous hair. Yes. I would also point out that apparently in twenty seventeen, reportedly Trump did not reappoint Janet Yellen for the role because she was too short.

And I, as you know, am all of five foot two, so I think all in all this is me and you both ruled out for Fed's yeah so Kevin Walsh. Yes. It was going to be one of the Kevins, people thought, and this is the Kevin of choice. Market's kinda like him. How do we know that and why? Well, we know it because neither short-term interest rates nor the dollar weakened on the announcement, which if it had been the other Kevin Hassett.

We might have anticipated some weakness suggesting a Fed that is fully in the thrall of the president and willing to cut rates and loosen monetary policy willy-nilly. So we got the news that it was going to be Kevin Walsh, and it's not like...

Stocks and bonds and the currency were all like hooray and there was this like massive jump in asset prices and the markets were like cheering, people were throwing streamers out of their windows and having parties and saying, Hooray, it's Kevin Walsh. But nothing bad happened.

Nothing bad happened. And that is these days a win. Yeah. I would say that's right. And the of course the interesting thing about Mr. Walsh is you can see in him what you want to see because he holds two views about monetary policy that on the surface at least point in opposite directions. He has been vocal in the last year or two that interest rates, the federal funds rate can be lower.

Now there's a whole debate about whether he's just auditioning for the job when he says that and is he a hypocrite and a fake and we can talk about all that. But that's one view that recently he's firmly espoused. His other view that he's been espousing for decades. is that the Federal Reserve's balance sheet which is big because of quantitative easing or bond buying should shrink. And that's a tight money.

So this guy both has a loose money view and a tight money view. So you can totally roar shark on him and see whatever image you want to in a certain way.

Yeah, so uh there's that, right? He kind of calls sort of for opposite things at the same time, but there is a large body of criticism of Kevin Walsh saying, and here I'm looking at the word in the New York Times from uh Catherine Rampell, who says that over time, Walsh has seemed more interested in slamming the brakes on the economy when a Democrat is in the White House than when a Republican is. So there is a concern out there that Walsh is a bit of a political beast.

that he is keener on raising interest rates when there's a Democrat in the White House and now that it's someone who appears to be more closely aligned with his broader political views, is happy to run the taps a little bit hot. I guess uh from what you've been writing in your newsletter over the past few days

You kind of disagree slightly on how important that is, right? Aaron Ross Powell I mean I have the dark view that all people are hypocrites and that they r respond to the incentives that they're exposed to in a given moment. And so Let me put it this way. This guy's life is about to change in a huge way. I describe him as The dog who caught the car.

He used to be on the Fed board. Yep uh d back during the financial crisis. You know, I think he resigned in twenty eleven. And even then he was kind of in an internal dissident. He was sitting there saying, Whoa, whoa, whoa, whoa, let's slow down with this QE stuff. Let's not uh and again, Obama was president, let's not let's not go so crazy with policy here. There's gonna be inflationary implications. So he was a dissident and very much in the minority and he was like standing by the sidelines.

Saying, well, maybe you guys are screwing it up. And since he left the Fed, he's basically been a professional Fed critic for fifteen years. Like you guys you guys are doing it wrong. Here's the way you should be doing it, nah nah nah. Well, if he gets approved by the Senate, he's gonna have to get off the sidelines and get in the game. He's gonna be accountable in a huge way.

And he's gonna be under a very, very different set of incentives and under very, very different pressures than he's been for the last two decades. So whatever happens, we're gonna get a new person, a person we haven't seen before. Yeah. So d to quote your words back at you from your newsletter the other day, for fifteen years Walsh has been able to criticise the Fed from the outside with nothing at stake. Now he has to put his money and ours on the table.

That's a good point, right? And i people do tend to act somewhat differently when they're actually in charge than from when they're in the peanut gallery kind of just Saying, Oh, I wouldn't I wouldn't do it like that. And and in the case of the Fed chair, by the way, the job is literally designed to cause that to happen. The job, the structure of the institution and of the chair's job is designed to insulate

the chair from pressure from the executive branch. So Trump talks about how it's incredible how people change their views when they get the job. Yes, that is true, and it is the whole point.

Right. So Yeah. But Trump also apparently was at a dinner at the weekend and he made a little joke. saying, Oh, you know, I'm I'm I'm nominating Kevin Washington and if he doesn't cut rates quickly I'm gonna sue him. It's like ha ha ha hilarious. Very funny joke. Please don't do that. Uh your majesty, you are cool, you are so funny. Uh uh

Let's get to a little bit more on that in a minute. But in the meantime, another thing that you've been writing about and that Chris Jarles has been writing about is that Walsh is cut from a somewhat different cloth than Jay Powell, who is currently the Fed chair, in the sense that Jay Powell with his little half moon glasses is very much like

He's data dependent. He is he his his public line has always been, I'm not wedded to one path of action or another. I will go where the data tells me and I will do whatever is in the best interest of the economy according to my mandate. Whereas wash is a bit like I've got a I've got views uh and and and I think that that they're gonna work out in in certain ways. So his big one is around productivity.

And he says, you know, we've got AI, we've got all this wonderful whiz bang technology and I think that's going to make everyone much more efficient, which is going to pull down inflation. Fine. That might be right, that might be wrong. But currently we don't know. Which is makes it a bit of a sketchy thing to base policy on. Okay, so just just to make sure We understand the argument here. The argument here is you get inflation. when demand exceeds

the capacity of the economy to supply that demand, right? So Mm. The idea is if you get more productive the economy can give you that more stuff so prices don't have to go up. There's just more stuff and everyone's happier. That's why productivity is so So important, right? Is it it's what kind of wealth and dreams are made of. Okay, that's all good.

Now, Warsh's view is that the AI revolution is a bit like the internet revolution in the nineties, in that you didn't see that something big had happened in the productivity statistics. But Greenspan, who was chair then, was right not to raise rates because he knew the productivity was coming, even though he couldn't see it. So he wants to be Greenspan two for the AI revolution.

Hm. He also thinks with limited evidence that you can cut the Fed's balance sheet, right? So you can kind of work down on this massive pot of money that the Fed controls. without that messing up credit markets and without it causing any sort of accident. Now again, he may well be right on this.

But it is a bit of a punt, isn't it? It is, although I will say in his defense. that the Fed did just go through a long period of allowing the balance sheet to run off. Again, what that means is they have all these bonds that they've bought. And what they did for a while was when one of those bonds expired.

they didn't replace it with another one. So they sort of let the balance sheet get smaller. So between twenty twenty two and just recently, you know, a couple of trillion dollars or about twenty five percent of the balance sheets O of the Federal Reserve's balance sheet. disappeared, right? And nothing terrible happened. And what he's saying is we could do more of that. We could just let this thing wind down further with no harm. Now. There's a lot of people out there. Who think?

When the Fed when the balance sheet shrinks, when the Fed's balance sheet shrinks, what it does is basically suck cash out of the financial system. In other words, for reasons too technical to describe, the net effect of it. is that you have more bonds and less cash floating around in private hands in the financial system. But the demand for cash, the need for cash doesn't go down. So the big worry is you have a kind of cash panic.

Somebody needs to pay off a short-term loan or roll over some debt, and there's just not enough cash sloshing around in the financial system. for that cash to be made available. A lot of it also would depend on how quickly he wants to wind down the the balance sheet, right? If as you say, you're just in a situation where bonds mature and you just don't buy any more bonds, then fine. That sort of is a process that is pretty much like watching paint dry.

If however you go down the Bank of England route and actively sell stuff that you own as a central bank, that can put more upward pressure on borrowing costs actually and and push down the value of bonds. So It there's a kind of pacing thing here that can be a little bit different. Absolutely a huge pacing system. And also there's all kinds of other factors. You know, there's a lot of factors that affect

the liquidity in the financial system beside the Fed's balance sheet. So if you shrink it when times are good and people are willing to lend and credit conditions are loose and banks are throwing money out their windows, everything's fine. The question is if the Fed is shrinking its balance sheet at a moment where people are scared and financial conditions are tight, then you could get a real problem. The big context here that you have to keep in mind is the huge

fiscal deficits of the United States. Spending money you do not spend money we don't have. And so when that when the government is doing that, they're pushing all this debt into the financial system that has to be bought by someone. And that's cash absorbing too. Right? So what you know, the financial system has to be kept flush with cash because somebody's gotta buy all the US debt. Yeah. And lower interest rates. And Warsh has this view that if you tighten the balance sheet.

the deficits will go down. In other words, he thinks loose monetary policy in the form of Federal Reserve bond buying is actually encouraging deficit spending. The usual view of course is that the causality runs the other direction, that there's huge deficits so there has to be bond bonds. But he he he reverses the arrow of causation, or at least thinks the arrow goes both ways.

So and I think that may be a fantasy. In other words, just because he changes b Fed balance sheet policy doesn't mean the federal government is gonna get religion about deficit spending. I just don't think that's realistic.

One other thing sort of bubbling along here is that Walsh has not been one of the people really pushing back at the president's attack on the Fed. You know, he he's kind of, you know, stayed on the sidelines of that and has not been a particularly noisy voice in favour of central bank independence. No.

This leads me back to one of my hobby horses, which I swear I'm not wrong about. So a bunch of our lovely colleagues, including Claire Jones, Miles McCormick and Amelia Pollard wrote a lovely story the other day about ha how Walsh got the job, basically. And the sorts of people in the room or in the process that really managed to win over Scott Bessant, the Treasury Secretary, who was advising on on the nomination, were those who were looking for regime change at at the fair.

And there is this sense that there could be some sort of more fundamental overhaul of the Fed's mandate or the way that it works. Wha what's your take on that?'Cause again, that could be quite subtle and probably not the sort of thing that most, you know, n ordinary people in the street would notice.

Or it could be a really big rewriting of what the Fed is for. Are you still writing off the possibility that its mandate could get like a do over? Because I'm not sure. I think the Fed under Walsh and most importantly, even under a Walsh and A m open market committee that is sympathetic to Warsh, meaning let's let's assume that he talks all the committee members over to his side and he's a really powerful Fed chairman and he can do what he wants.

You know, what do we think he wants to do? I don't think he wants to get rid of the employment mandate or the stable prices mandate or anything like that. I do think he thinks the Fed is just too big. So I wouldn't be surprised to see him say things like, Let's sack loads of people, let's do less research, let's slim this whole thing down, let's stop writing papers

about economic inequality and et cetera, et cetera. Let's just bare bones it a little bit. And, you know, those are the kinds of noises he makes. He also makes noises about the Fed and the Treasury cooperating more on monetary policy implementation. Yeah. And if you're a markets person that rings a little alarm bell in the back of your head saying, Hmm, how far could that go? Yeah, what does that mean? The bad version of that is where the Fed becomes a servant of the treasury.

And the Treasury wants to do X. And the Fed's job with its monetary policy levers is just its little minion. Warsh's talk about higher Fed Treasury cooperation absolutely should make you Jumpy and it is the camel's nose getting into the tent, and I don't like it. Rob, we are going to have to come back in just one second with long.

Okie dokie, it is time for long short, that part of the show where we go long a thing we love or short a thing we hate. Rob, what you saying? I'm long the theme park. Uh I notice that the next CEO of Mighty Disney is gonna be the guy, Josh Damaro, who used to run the theme park division. And I'm I'm old enough to remember like a decade ago, people would look at Disney and be like, Why do they even run those stupid theme parks? They're so much more unprofitable.

Then the movie business and the T V business. The world has changed and like suddenly the best part of the business is the live part where you go and actually do stuff. So uh while I personally don't like going to theme parks I think man, that's a good business and in the world of AI especially. Theme parks, it's the future. Once once we don't have to work anymore because AI does everything, we're just basically going to theme parks all day. You're gonna spend all day on roller coasters.

I'm I'm kinda down with that. I l I like roller coasters. Me too. On a r on a related ish note, I am short grind core. So I don't know if you saw the piece the other day from Hannah Murphy on our papers about this whole like work hard, don't play at all thing that like thrusting young Silicon Valley people do. Apparently they're all into this thing called nine nine six, right? Which means you work from nine AM to nine PM, six days a week.

And there was a quote in her story from some twenty three year old guy from an AI startup who was saying The current vibe is no drinking, no drugs, 996, lift heavy, run far, marry early, track sleep, eat steak and eggs. And die of boredom. Go to a sodding theme park, guys. Like seriously. Like like no get drunk at Epcot Center like a normal person. Right.

So if you are twenty three and you're listening to this and you're eating eggs and going to bed early and not drinking and having zero fun, you're doing it wrong. You are working for the man. Trust me. when you get to my age and certainly when you get to Rob's, you are not capable of having that sort of fun any more.

So you are wasting time. So that's my advice. Now listeners, we're gonna be back in your ears on Thursday. Listen up then, and in the meantime, thank you for your attention to this matter. Unhedged is produced by Jake Harper and edited by Brian Erstadt. Our executive producer is Jacob Goldstein. We had additional help from Topha Forhead. Cheryl Brumley is the FT's global head of audio. Special thanks to Laura Clark, Alistair Mackey, Greta.

Cohn and Natalie Sadler. FT Premium subscribers can get the Unhedged newsletter for free, and a 30-day free trial is available to everyone else. Just go to FT.com slash unhedged offer. I'm Katie Martin. Thanks for listening.