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President Trump's Pick for Fed Chair

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President Trump's Pick for Fed Chair JOHN L. BELLOWS, PhD Portfolio Manager / Research Analyst POLICY MATTERS August 2017 President Trump’s Pick for Fed Chair Executive Summary “[Yellen] is not a Republican. When her time is up, I would most likely replace her because of the fact that I • Fed Chair Janet Yellen’s term think it would be appropriate.” ends in February 2018, with no clear successor yet identified. “[Yellen] is a low-interest-rate person, she’s always been a low-interest-rate person, and let’s be honest, I’m a low-interest-rate person.” • President Trump has made it clear he is interested in keeping interest rates low and ~Donald J. Trump, CNBC Interview, May 5, 2016 leans toward selecting a fellow Republican. With Janet Yellen’s term ending in February 2018, the sweepstakes for Federal Reserve (Fed) Chair is heating up. Media stories about who is favored are appearing with increasing frequency and attracting a lot of attention. • One possible choice, not Potential candidates are trying to raise their profiles and thereby increase their chances. Furthermore, our clients currently on most investors’ radars, would be Jerome regularly ask us for our view on who President Donald Trump will pick. Our honest answer is “We don’t know, nor Powell whose views on does anybody else.” That stated, we can make some informed observations. While we may or may not get the accommodative policy and name exactly right, our thought process, detailed below, may be a helpful guide to watching the contest heat up political affiliation meet the over the coming months. President’s stated criteria. At this stage, our approach is to treat the media speculation as just that—speculation. It’s almost certainly too early for the President to have made a final decision. In 2013, President Barack Obama announced his choice of Janet Yellen in the first week of October. The current White House has lagged somewhat in making presidential appointments, suggesting the possibility that Trump’s pick will be announced even later in the year, and meaning a final decision could be more than two months away. Moreover, the appointment process can and likely will take unexpected turns between now and any official announcement. For example, Mitt Romney was a media favorite to be nominated as Secretary of State, and very few commentators even had Rex Tillerson on their list of finalists. Rather than putting too much weight on the media reports, we prefer to build our own view based on a combina- tion of what Trump has said, our understanding of Trump’s economic priorities and the historical precedents. It is within this context that we find the two quotes above informative and helpful. On their faces, these two state- ments are somewhat contradictory with regard to reappointing Janet Yellen. But at a deeper level they suggest that President Trump has a pretty clear idea of the characteristics he is looking for: Trump wants his Fed chair to be a Republican, low-interest-rate person. Republican or Democrat? The choice of Fed chair is inescapably political. Accordingly, previous presidents have prioritized political affiliation when making their selections. We are inclined to take Trump’s mention of Yellen’s political party as intentional and in line with recent history. Let’s not forget that Yellen served as the Chair of the Council of Economic Advisers under President Bill Clinton, so her affiliation with the Democratic Party is hardly a secret. An instructive example of the importance of political party can be seen in the transition from former Fed Chair Paul Volcker to Alan Greenspan. Volcker had earned his reputation as an independent central banker by pursuing tight monetary policy in the early 1980s, even though the social costs were significant and there was intense political pressure to lower interest rates. In 1982, a year during which the unemployment rate reached 10.8% and overnight Western Asset 1 August 2017 POLICY MATTERS President Trump’s Pick for Fed Chair John L. Bellows, PhD interest rates were above 15%, President Ronald Reagan complained publicly that Volcker and the Fed were “hurt- ing us, and what we’re trying to do, as much as they’re hurting everyone else.” A few years later in 1986, James Baker Western Asset Management Company III, who at the time was Secretary of the Treasury, was worried about the risks posed by an independent Fed as he Portfolio Manager / Research looked forward to the upcoming presidential election. In particular, Baker was concerned about Volcker, because Analyst, 2012– he feared excessively tight monetary policy could work against the incumbent party’s chances. As an initial step U.S. Department of the Treasury toward moving Volcker out, Baker extracted a promise from a newly appointed Fed Board governor that he would Acting Assistant Secretary for vote against Volcker at his first opportunity. Volcker lost an internal vote immediately after this governor joined Economic Policy; Deputy Assistant Secretary for Microeconomic the Board in February 1986. Without the support of the Board, Volcker saw his position as untenable, and he con- Analysis; Senior Advisor in sidered resigning that very afternoon. Volcker ended up serving another year and a half, although in a somewhat the Office of Economic Policy, diminished capacity, before informing President Reagan that he would prefer to step down rather than serve a 2009–2011 third term1. University of California, Berkeley, PhD Economics It’s clear that Volcker was a casualty of politics, but was Greenspan part of Baker’s plan? In short, yes. Everything Dartmouth College, Baker knew about Greenspan made him a good fit for the role. Baker had no reason to doubt Greenspan’s Re- BA Economics, Magna Cum Laude publican Party affiliation. Greenspan had worked as an adviser on Nixon’s 1968 presidential campaign, where his responsibilities included not only economic policy but also advising on messaging and strategy with regard to the Electoral College. Greenspan later worked in President Gerald Ford’s White House as the Chairman of the Council of Economic Advisers. During that period, Greenspan generally favored lower interest rates, although from his post at the White House he did not have any responsibility for monetary policy. In any case, given his long history with Republican candidates and presidents, Greenspan seemed likely to be a much safer choice ahead of the 1988 presidential election2. The Volcker to Greenspan transition is just one example of how politics influences the selection of the Fed chair, though it is arguably not the most troublesome. A more egregious example was when President Jimmy Carter selected G. William Miller to be Fed chair in 1978. Prior to becoming Fed chair, Miller had very little monetary policy experience (he was the CEO of a manufacturing company), but he had worked closely with Democratic presidents and party fundraisers in multiple roles. This proved to be the wrong mix of skills and, perhaps predictably, Miller struggled in his role as Fed chair, lasting only 17 months before exiting without distinction (Exhibit 1). Exhibit 1 Chairs of the Federal Reserve, 1935–2017 Chair Tenure First Appointed by No. of Yrs. Served Marriner Eccles (R) 15 Nov 1934–15 Apr 1948 FD Roosevelt (D) 13 Thomas McCabe (R) 5 Apr 1948–31 Mar 1951 HS Truman (D) 3 William M Martin (D) 2 Apr 1951–31 Jan 1970 HS Truman (D) 19 Arthur Burns (R) 1 Feb 1970–7 Mar 1978 R Nixon (R) 8 G. William Miller (D) 8 Mar 1978–6 Aug 1979 J Carter (D) 1 Paul Volcker (D) 6 Aug 1979–11 Aug 1987 J Carter (D) 8 Alan Greenspan (R) 11 Aug 1987–31 Jan 2006 R Reagan (R) 18 Ben Bernanke (R) 1 Feb 2006–31 Jan 2014 GW Bush (R) 8 Janet Yellen (D) 3 Feb 2014– B Obama (D) 4 Source: St. Louis Fed, NY Times, Western Asset. Number of years served have been rounded, 0.5 rounded up 1 Silber, William. Volcker: The Triumph of Persistence. New York: Bloomsbury Press. 2012 2 Mallaby, Sebastian. The Man Who Knew: The Life and Times of Alan Greenspan. New York: Penguin Press. 2016 Western Asset 2 August 2017 POLICY MATTERS President Trump’s Pick for Fed Chair Low-Interest-Rate Person The emphasis on political party is not all that surprising, given how consequential Fed policy can be for electoral outcomes. Any newly elected president will do everything in their power to boost job growth and raise asset prices, and President Trump is no different in this respect. However, the emphasis on low interest rates may be especially important for President Trump, as maintaining low interest rates would appear to promote two of his priorities: infrastructure and manufacturing. Infrastructure The link between low interest rates and construction is obvious and probably doesn’t need to be explored further here. It’s plain to see that President Trump is very familiar with the importance of low financing costs to the overall viability of construction projects. Our view has been that it will be difficult for Congress to pass legislation that substantially increases funding for infrastructure. There does not appear to be consensus within the Republican Party regarding the benefits of such a program, in particular how it should be paid for, and Democrats have been reluctant to work with the President. The slow progress on the rest of the legislative agenda has further diminished the prospects for a large spending bill. However, rather than deterring President Trump’s enthusiasm for infrastruc- ture, this may have the effect of making him even more focused on the boost that low interest rates provides to private developers and builders.
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