Trump(dis)order: Worst is not attack on Fed Chair Jerome Powell but weakening strength of US institutions

US President Donald Trump

Fed Chair Jerome Powell 

Central banks are an organ of society and not of the political authorities. They have a mandate to keep the value of money they have issued at a stable level. Therefore, they are to serve the people and not the political authorities. But the political authorities get angered by central bank’s action when such action does not serve their narrow objective of remaining in power. In this context, it is not only Jerome Powell who has been attacked unfairly by political authorities who believe that they have superpowers to direct central banks to work for them. There are many other central bank heads who have received the same treatment from political authorities

Trump calling Fed officials boneheads

President Donald Trump, giving vent to his deep-rooted displeasure at Fed Chairman Jerome Powell’s public statement that Trump’s tariff policy will lead to inflation, slowdown in economic growth, and cause job cuts, retorted wildly that he wanted to sack Powell.1 His only worry was that it would not come earlier than necessary since Powell was to serve as Fed Chair till the middle of 2026. When this pronouncement sent disastrous ripples through the financial markets causing sharp falls in stock prices as well as the value of the dollar, Trump took a step backward later that he had no intention of sacking the Fed chairman.2 But by that time, the damage had already been done and the dollar’s downward journey in terms of the price of gold, though rebounded temporarily to the news of potential de-escalation of the tariffs war, had reached the historical low levels.3 

Ironically, Jerome Powell, the investment banker and lawyer, was installed as the Chair of Fed by Trump himself in 2018 during his first term as the President. Later, Powell was given an extension of further four years by Trump’s successor to Presidency, Joe Biden, proving that Powell as the Chair of Fed is acceptable to both the Democratic Party and the Republican Party. However, during his first term too, Trump did not have a good professional relationship with Powell. When Trump’s request for lowering the US interest rates to negative levels was not acceded to, Powell as well as those in the Fed were called ‘boneheads’ or ‘stupid people’ by Trump.4

Negative interest rates

When Trump was asking Powell to adopt a negative interest rate policy, there were instances of such a policy being followed by European Central Bank, Sweden, Switzerland, Japan, and Australia. The mechanism for a central bank to make interest rates negative is twofold: one mechanism is, on the deposits which a commercial bank makes with the central bank, instead of paying interest, by charging a fee for such deposits; the other is, when a bank borrows from a central bank, by paying interest to the borrowing bank by having a negative REPO or Repurchase rate. In the first case, banks are encouraged to lend to customers instead of parking excess reserves with the central bank. In the second case, banks are encouraged to borrow money from the central bank and lend to customers without sourcing such funds from the depositors. 

Both measures cannot be practised too long since they do irreparable damage to the stability of the financial system by drying up savings flows, encouraging consumption, and diverting investments to low or unproductive sectors making them a burden to the economy. Hence, the policy of negative interest rates is a very short-term measure to push the inflation rate which is running below the target rate for a considerable period. Therefore, once the inflation rate moves up, the negative interest rate policy should be abandoned.

Fed refusing to accede to Trump’s demand

In any case, USA did not have a case for a negative interest rate policy in 2016 to 2019. Its average inflation rate has been at about 2%, the target rate of inflation by the Fed. Though the Fed could go for a little lower inflation rate than the target rate under its flexible inflation target policy, the prevailing rate did not warrant for such a flexibility in the target. Hence, like a good central bank concerned about the long-term macroeconomic stability, Powell and his team did not yield to the request for a negative interest rate policy earning the derogatory name of being stupid people from the country’s head of the state. 

In the present case, after he had messed with the country’s macroeconomic stability through an unjustified tariff revision, Trump wanted the Fed to lower interest rates to help him to stimulate the economy. Since the high tariff rates were to increase the future inflation through increased inflation expectations, the Fed did not accommodate his request. This was the reason for the dispute which Trump had with Powell and his team.

After he had messed with the country’s macroeconomic stability through an unjustified tariff revision, Trump wanted the Fed to lower interest rates to help him to stimulate the economy. Since the high tariff rates were to increase the future inflation through increased inflation expectations, the Fed did not accommodate his request. This was the reason for the dispute which Trump had with Powell and his team

Central bankers are at receiving end

Central bankers are always at the receiving end when it comes to dealing with political authorities.

As I have argued elsewhere, central banks are an organ of society and not of the political authorities.5 They have a mandate to keep the value of money they have issued at a stable level. Therefore, they are to serve the people and not the political authorities. But the political authorities get angered by central bank’s action when such action does not serve their narrow objective of remaining in power. In this context, it is not only Jerome Powell who has been attacked unfairly by political authorities who believe that they have superpowers to direct central banks to work for them. There are many other central bank heads who have received the same treatment from political authorities.

Gotabaya Rajapaksa publicly blaming Central Bank officers

Misguided by this false view, Sri Lanka’s President during 2019-22, Gotabaya Rajapaksa, popularly called Gota, chose to publicly humiliate the key Central Bank officers when the camera was rolling on his outrage.6 He said that the people have given him a mandate to rescue the ailing economy but the Central Bank officers did not support him through an appropriate monetary policy. He questioned them whether they have a tool of theirs to prudently handle the conflicting goals of the fiscal policy and the monetary policy. He directed the Central Bank officers to come up with their tools before the daybreak the following day. 

It was pity to see the sheepish look on the faces of senior Central Bank officers, including the Governor, W.D. Lakshman, a reputed academic of the day, in an unpleasant encounter with the all-powerful executive President of the country. Thus, Gota, adhering to an unusual tactic of publicly humiliating the Central Bank officers, won his battle against the central bank for the day. But not for long as the subsequent events have revealed.

Disastrous accommodation of Gota’s demand

According to reports, the Central Bank officers had burned the midnight oil that day to keep to the deadline given to them by the President.7 But the policy compromise they had reached to pacify a raging President was disastrous. The Central Bank had wittingly allowed the Government to finance the rising fiscal deficit by borrowing from the banking sector made up of the central bank and the commercial banks. From December 2019 to July 2022, Government’s borrowing from the banking sector increased by Rs. 4.2 trillion or 150%. This was done at an accelerated pace during January 2021 to July 2022 after Gota berated the central bank officers in public. 

During that period, Government borrowing from the banking sector rose sharply by Rs. 4.7 trillion or 167%. The result was the sharp increase in the broad money supply by Rs. 4.7 trillion or 61% pushing up pressure on the prices to rise and the exchange rate to depreciate leading to a complete depletion of the country’s foreign reserves.8 The inevitable outcome was that Sri Lanka failing to honour its foreign debt obligations by April 2022 and, thereby, becoming a country of bankruptcy in action if not in context.

Supreme Court judgement

This led a group of concerned citizens to file a fundamental rights case against those who were responsible for making the country bankrupt through irresponsible and reckless economic management. Delivering the judgment in this case, the five-member bench of the Supreme Court of Sri Lanka, in a division of 4 to 1, found those who were responsible for driving the country to bankruptcy guilty of the breach of public trust, a principle which all public officials from the lowest to the executive president should observe. 

That included Gota, his brothers, Mahinda Rajapaksa and Gotabaya Rajapaksa who were the ministers of finance, P.B. Jayasundera, the Secretary to the President, Central Bank Governors W.D. Lakshman and Ajith Nivard Cabraal, S.R. Attygalle who was the official member of the central bank’s Monetary Board by virtue of being the Finance Secretary, and Samantha Kumarasinghe, the outside Monetary Board member.9

The wrath of the law did not fall on two other members of the Monetary Board, Sanjeeva Jayawardena and Rani Jayamaha, because they had objected to this policy throughout and the two senior Deputy Governors of the Central Bank, namely, Nandalal Weerasinghe and Mahinda Siriwardena, who took over the mantles of the Central Bank and the Ministry of Finance, respectively, in April 2022, because the reckless policy had been implemented against their recommendation as quoted by the Supreme Court in its judgment.10 These last two officers have earned the commendation of the financial markets throughout the world for avoiding a bigger disaster and pushing the country along a sustainable growth path. In April 2022, I expressed my confidence in their ability to rescue the country from the imminent disaster in an article in this series.11 Both of them have now proved the worth of their salt.

Also, it is worthy to note that a mass agitation against Gota and his brothers in mid 2022 removed all of them from political power, the first occasion in Sri Lanka’s history to happen such a change of power outside the established electoral system.

This historic judgement by the Supreme Court of a third world poor country is a lesson for all recalcitrant political authorities throughout the globe and those who run central banks. The lesson is that the political authorities should not play with central banks for personal gains and those in central banks should not be a yielding hand to them.

Difficult task of firing Fed Chair

Though Trump announced that he wanted to change the head of Fed, he cannot do so in terms of the law. Like in other central banks which enjoy such independence from political authorities, for the President to sack the chairman of Fed, he must prove that the incumbent is inefficient or negligence of duty or corrupt. It is a long and difficult procedure but not impossible for a President who is determined and has majority power in both houses in USA. 

But financial markets in USA had cold feet about Trump’s intention and overly reacted to it by causing the stock prices to plummet, US government security yields to rise, gold price to skyrocket, and US dollar to fall against major currencies. Thus, it brought in an irreparable damage to the financial system forcing Trump to soften his earlier hard stance. In the meantime, Powell without yielding to Trump’s threats continued to maintain that Fed will be working within the law since Fed’s independence was a matter of law.12

His attack on the Fed Chair has not only caused financial turmoil but also weakened the dollar as a reserve currency. All these actions have created uncertainty in the minds of the people adversely affecting the investment flow in the country. With this weakened institutional setup, it is unlikely that USA will continue to be a great nation in the global political and economic landscape

Why nations fail

A nation will fail if that nation’s institutional setup is weakened either in a natural cause or by political action. This was the thesis which economists Daron Acemoglu and James A Robinson presented in their pathbreaking publication in 2012, Why Nations Fail: The Origins of Power, Prosperity, and Poverty. Institutions in economics are not just formal institutions like corporate bodies, NGOs, or voluntary societies. They are the rules, organisations, and frameworks that structure economic activity and shape behaviour. Thus, they encompass both formal and informal constraints, including laws, contracts, property rights, and cultural norms.13 

It is the human beings who have devised institutions to bring about order and reduce uncertainty in conducting transactions among them. They evolve through time in small doses of growth and connect the past with the present and the future. Since these institutions build the incentive structure of the economy, they are the ones that shape the direction of economic change toward growth, stagnation, or decline. Growth will come if the institutions are constructive, and decline will be the outcome if they are destructive or extractive. USA as a nation has built a strong institutional structure that had permitted it to remain a nation of worth in the global arena.

Weakening American institutions

Trump through his economic policies relating to migration, trade, education, research and development, and the courts system has weakened the institutional structure in the country. USA is a country built on migrants but Trump through his non-tolerant immigrant worker policy has put a stop to the migrants’ flow. He has attacked research universities like Harvard and Columbia which have contributed immensely to the development of innovative knowledge base of Americans. When the court system began to deliver judgements nullifying his executive action, he immediately attacked the judges and courts. He has taken action to dissolve the Federal Education Department in a bid to save money for the budget. His attack on the Fed Chair has not only caused financial turmoil but also weakened the dollar as a reserve currency. 

All these actions have created uncertainty in the minds of the people adversely affecting the investment flow in the country. With this weakened institutional setup, it is unlikely that USA will continue to be a great nation in the global political and economic landscape.

This is the biggest issue faced by USA as a nation today.

Footnotes:

1https://apnews.com/article/trump-powell-federal-reserve-fed-termination-b6148c8048dda538a6ca3b5a270fd09e

2https://www.reuters.com/world/us/trump-no-plans-fire-fed-chair-powell-wants-lower-rates-2025-04-22/

3https://www.barrons.com/livecoverage/stock-market-today-042225/card/gold-is-at-historic-levels-even-when-you-adjust-for-inflation-0HDzTom5btWlPjt0ypbv

4https://finance.yahoo.com/news/trump-calls-jerome-powell-and-fed-boneheads-former-economic-adviser-says-hes-right-215346184.html

5Wijewardena, W.A, 2022, Central Bank Independence: Issue to the fore again, but will the government have foresight to do it? (available at: https://www.colombotelegraph.com/index.php/central-bank-independence-issue-to-the-fore-again-but-will-the-government-have-foresight-to-do-it/)

6https://youtu.be/k95qTA5q22U?si=ejHRVljNNdg5Nk2m

7https://www.sundaytimes.lk/200621/columns/presidents-tongue-lashing-leaves-central-banks-top-brass-red-faced-406326.html

8For details: see: https://www.ft.lk/columns/SC-judgment-fiscal-philosophy-and-long-term-decisions-for-a-brighter-future/4-755609

9Supreme Court Judgment available at: https://www.lankabusinessonline.com/wp-content/uploads/2023/11/sc_fr_195_and_212_2022.pdf

10Ibid, pp 117-8

11https://www.ft.lk/columns/Welcome-Nandalal-and-Mahinda-But-you-both-have-Herculean-tasks-ahead/4-733303

12https://www.ft.com/content/e7140acd-cb22-4b51-8abe-41a251c35d73

13North, Douglas C, 1991, Institutions, Journal of Economic Perspectives, Vol 5 No 1 pp 97-112, (available at: https://www.aeaweb.org/articles?id=10.1257/jep.5.1.97#:~:text=Institutions%20are%20the%20humanly%20devised,%2C%20laws%2C%20property%20rights).

(The writer, a former Deputy Governor of the Central Bank of Sri Lanka, can be reached at [email protected].)