PETER NAVARRO: Powell and his Fed allies can box in Warsh and the growth of the hammer
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Kevin Warsh has now been sworn in as the new Chairman of the Federal Reserve. Outgoing Chairman Jerome Powell has refused to leave the Fed’s Board of Governors, breaking with the modern tradition that outgoing Fed chairs leave the Board rather than remain as rival powerhouses.
The danger is clear: Powell will have enough Board support to serve as Fed Shadow Chairman and force a series of rate hikes down Warsh’s throat.
Don’t forget that even a one rate increase would be a very negative response to an oil price shock. Don’t forget that Jay Powell’s two predecessors understood the difference between demand inflation and an oil shock.
When Iraq invaded Kuwait in 1990, Alan Greenspan understood that an oil shock would increase inflation and hurt growth. His FOMC repeatedly cut the federal-funds rate as the economy weakened.
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While oil, food, fertilizers, and industrial metals all rose sharply in 2008 – driven by growing emerging market demand, limited supply, tight spare capacity, and speculative flows – Ben Bernanke’s Fed also lowered the federal funds rate in April. He then held back in June and refused to launch a campaign to raise the rate of recession at rates the Fed can’t drill, refine, mine, machine, or ship.
That’s the average error that comes up. The Fed cannot produce one more barrel of oil. Unable to reopen the shipping route. You cannot refine gasoline. You can’t lower the cost of diesel by suppressing housing demand in Ohio or forcing a small producer in Pennsylvania to take on debt at punitive rates.
A Fed rate hike now will strengthen demand due to a supply shock and hit an already vulnerable economy. Housing will be even weaker. Unprofitable production of interest will suffer. Small business credit will strengthen. Financial conditions will tighten as energy prices eat into real wages. The dollar could strengthen, putting pressure on exporters.
Memo to the Fed: Oil shocks already equate to tax hikes. It takes money out of the household budget, increases travel costs, squeezes margins and slows down real work. If the Fed puts another rate hike on top of that, it doesn’t solve the oil problem. It simply adds a credit shock to the energy shock.
What does that do when bond market watchers are already doing the job of restrictive policy. The 30 year Treasury yield north of 5% and the ten year north of 4.5% is not loose money. Mortgage rates, business borrowing costs and duration-sensitive assets are already feeling the heat. In that climate, the central bank does not need to prove its strength or independence by firing another round into the ship.
And April’s inflation reports are not an argument for panic. Core PPI came in slightly warmer at 4.4% but core CPI was 2.8%. There is no number that justifies handling a power-driven asset shock as a demand-side emergency.
The right question is whether the oil spike will spill over into the context and create a second round of earnings price volatility. We still have a long way to go before we know, and the Fed should not be in the business of playing worst-case scenarios.
Instead, the Fed’s job is as it should always be, keeping inflation expectations grounded while keeping employment high. As long-term bond yields rise, the risk shifts toward a recession – as Greenspan and Bernanke understood long ago.
This is where the idea of Powell as Shadow Chairman rears its ugly head: Three governors nominated by Biden – Philip Jefferson, Michael Barr, and Lisa Cook – live in the area. Powell and the Biden trio can now command a four-vote majority on the seven-member Board. It’s bad enough.
If Trump nominee Christopher Waller proves to be a key defector, as he has signed, this will turn Powell’s Shadow Chair majority into a challenge. Warsh will headline. Powell will control the response function.
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And the Fed’s regional presidents in Cleveland, Minneapolis, and Dallas — Beth Hammack, Neel Kashkari, and Lorie Logan — are already lining up choruses of a possible hawkish pivot.
It is in this Shadow Chair equation that Kevin Warsh – and the American economy – may enter the box. If Powell, his Biden-era allies, and the regional hawks force a campaign to increase the oil shock rate, they will not protect the Fed’s credibility or prove its independence. They will be adding a credit shock to the energy shock – and prove only negligent. The bill will come not to the Eccles Building, but to factories, homes, small businesses, and export markets across America.
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