The Next Chair: Warsh and the Future of the Fed

MIKE BARNES 0:10

Welcome to America’s Gold Authority Podcast. My name is Mike Barnes. Jerome Powell has been in the headlines a lot lately for the last year, year and a half, but that could change in May when Kevin Warsh takes over as the chair of the Federal Reserve. We’re going to talk about that transition with a couple of experts. Philip Diehl and Brad Chastain joined me. And Philip, I want to start with you because you’ve kind of been in this situation with the transition as the 35th Director of the U.S. Mint. What’s the transition going to be like with Jerome Powell to Kevin Warsh?

PHILIP N. DIEHL 0:39

Well, thank heavens I wasn’t under federal investigation when I was uh in transition. Uh that’s a situation that uh that uh Jerome Powell finds himself in, where the Trump administration has launched an investigation of whether or not he has had some role in the cost overruns of uh the uh remodeling of the Federal Reserve building. I I think there’s a general consensus that uh his hands are clean in that matter. Uh, but in any case, it has really become a sticking point on when Kevin Walsh might take over as chairman of the Federal Reserve Board. There’s a Republican senator on the committee who holds the crucial vote on uh advancing Kevin Walsh’s nomination to the Senate floor. He has said, and he’s been sticking to it, that he will not vote uh in committee to advance that nomination until the investigation has been dropped and closed permanently. And uh and so we have a situation in which uh Kevin Walsh might not be confirmed by the time he is due to uh go into the position as chairman, in which case um uh the chairman has said that Chairman Powell has said that he will continue as chairman until his successor is confirmed. So uh it’s an open question about when Walsh will join the the uh the board. And another unusual aspect of this is that um is that Chairman Powell has the opportunity to remain on the board uh as a regular board member for about two years. And usually chairmen when they uh when they uh their term expires leave the board. But uh Chairman Powell is really focused on protecting the independence of the Fed, and he believes he can advance that agenda by by uh staying on the board until the end of his term.

MIKE BARNES 2:52

Philip, I’m glad you mentioned the board because Brad, it’s not just the chair that runs everything. There is a board of governors, so it’s not a one-person dictatorship, so to speak.

BRAD CHASTAIN 3:03

That’s correct. Yeah, there in fact, there’s about 18 members on the board that are all involved in the in the process. Uh, I think 12 of them vote, uh, seven of them being Fed governors, and then there’s another five or so that that rotate out of that overall 18 aggregate um vote. But everybody’s involved, and only a few of them actually place votes. But it’s not just the the Fed chair. The Fed chair’s role is really more of a shepherding um role to shepherd the committee through the process and ideally come to a consensus, which historically has been done most of the time that we’re uh throughout history. There were very few instances where a rate decision or a policy decision wasn’t uh a unanimous decision at the end of the discussion, kind of like in a trial where they try to get to a unanimous uh and not uh uh end up with a hung jury. In this case, there’s not a hung jury, the the vote goes through just based on a majority, but more recently we’ve seen quite a few dissents on a repeated basis. And I think that’s going to be the standard for a while. I don’t I doubt we’re gonna return to a consistent unanimous decision at the end given the the divisiveness that is uh design that does exist out there. But you’re right, the the fed chair is not the ultimate legis ultimate decision maker. They but they do play a very important role in in guiding everybody to uh a decision and a vote.

MIKE BARNES 4:26

Philip, if he’s only a shepherd, if he’s not the true decision maker, and there’s the the whole board that is there, why has Jerome Powell gotten so many headlines?

PHILIP N. DIEHL 4:36

Well, Jerome Powell’s been a uh an especially effective leader, whether you agree with his policy making or not, and in building consensus on the board. And uh that has eroded uh over the last year and a half or so, just as Brad described, as this deep division has developed, not just on the Federal Reserve Board, but uh in Washington, D.C. generally, and that’s between the so-called hawks and the doves on interest rates. The hawks are those who believe we ought to really be focused on inflation and we ought to keep interest rates higher for longer in order to prevent inflation from taking off. And the doves are those who uh believe we need to focus on uh economic growth and job growth, and therefore uh want to see interest rates cut. Uh the president, of course, and his administration are on the dove side. They’d like to see uh stimulation to the economy, looking forward to the off-season elections coming up in November and the general election in 2028. Uh and the Hawks are uh a more mixed group, more mixed flock, if you will, of people who are either Democrats or uh those who are even conservative who wish to uh really focus on inflation and not let inflation get out of hand. We saw what the consequences of uh inflation getting out of hand over a long period of time, all through the 70s, right into the late 70s, uh, when there was finally the commitment to fight in inflation, and we saw the Federal Reserve have to radically increase interest rates and hold them higher for longer in order to break the back of inflationary expectations in the marketplace. And really, no one wants to get into that place. Even the doves don’t want to get into that place, but they make an argument that uh there are changes in the economy that are coming, uh not in place yet, but are coming, and we can count on that to uh decrease any inflationary uh influences of cutting interest rates.

BRAD CHASTAIN 7:09

Yeah, and Mike, I’ll add the reason why pressure falls on on Powell is that’s always the case with Fed chairmans. They’re the ones that are the spokesperson, they are the ones that get credit for everything or blamed for everything. It doesn’t matter if it’s Arthur Burns or Paul Volcker or Greenspan or Bernanke or Janet Yellen, most people could never name the other members of the board during each of their tenures. It was Arthur Burns that gets blamed for the 70s. It was Volker that gets credited for stamping out inflation, even though in the same uh manner there there’s still a board that’s ultimately making the decisions. So that that’s that is normal. Now the the uh the actual pressure and political pressure on the Fed chair we’ve talked about is not necessarily normal, but it is normal that they uh are the ones that everybody refers to as green span cut rates um, you know, during the early 2000s or or so. But um it is a board.

MIKE BARNES 8:07

Well, Brad, that’s what I want to ask you about. Is you’ve got the hawks and the doves having their disagreement, but most of us just want to worry about the economy. How is it going to affect us? So, how do you think the transition and having a new chairman will affect all of us?

BRAD CHASTAIN 8:22

Yeah, I mean, there there’s kind of two things to in my mind to look at. One of them is the one that gets all the headlines, which is interest rates and what is the interest rate policy going to be. And Warsh has been, you know, quite a bit more dovish, meaning advocating for rate cuts uh aligned with the the president’s wishes as well. Uh his argument being that it won’t be inflationary because AI is going to be a deflationary impulse that will offset. So that remains to be seen if that’s the case and if AI really provides the productivity that would offset that. I think we talked about when he was first mentioned that the fact that that’s the case, we were talking about AI at the time. Um if the productivity gains don’t come in that kind of time, it seems like his policy would be a little bit offsides in terms of reality if that’s the case. Um, the other big part of it that’s getting more attention right now, too, is the what he wants to do with balance sheet. He’s been more hawkish on the size of the balance sheet. The administration has been. Uh Stephen Miren, who we’ve talked about, wrote a paper about restructuring global trade, which was before President Trump was in office, and it was really kind of the blueprint for the tariffs and the sort of trade rebalancing. Uh, he was on his chief economic uh council of advisors, and now he’s a Federal Reserve board member, one of the voting members. And he wrote a paper just a month and a half ago or so about a user’s guide to reducing the Fed’s balance sheet. So what he says, whether you agree with it or not, is something to not be taken lightly in terms of the strategy there. And that’s something that I think if they actually follow through with to the degree that he outlies, which is reducing it almost half, from like 2.1 to about 1.2 trillion, I think if I remember correctly. Um that’s significant. Um, even more significant, I think, than um small interest rate changes at the end of the day. Because the Federal Reserve’s actions in stabilizing bond markets, which ultimately drive the entire global financial system. They underpin the global financial system, they are collateral for the entire system, is so, so critical. And if they’re reducing the balance sheet, we already saw in the end of last year sort of what starts happening there. Most people didn’t feel it because the the financial markets were screaming loud enough that something was done about it at that time. But we talked about it at the time because it was it was obvious to anybody watching financial markets that as the as reserves were depleted because they bank reserves were depleted as they were reducing the bond holdings, short-term rates started getting out of control. The one rate that the Federal Reserve tries to really, really control, they started losing. And they had to start a new form of quantitative easing. They don’t call it that, of course, they call it reserve management purchases now, but they’ve gone in and started buying um uh buying back bonds, which is an expansion of balance sheet to try to stabilize that. And what they are proposing here is orders of magnitude larger than even what was done in that period of time. And it’s important because uh one, they stabilize bond markets that affect literally everything else. Um, and if they’re not doing that, it’s kind of where do all of the bonds flow? I know the administration wants to push a lot of them into the stable coin world that we’ve talked about a little bit as well. Um, but another part of it is bank reserves. As bank reserves decline, that’s what we call base money. A lot of people are familiar with the concept of M2, which is how much money is in checking accounts and savings accounts and in some money markets and cash. It’s kind of how much money is out there. But most of that, as we’ve talked about a lot, is debt-based. It was lent into existence. It was not created by the government or the Federal Reserve. Only a small portion of it is about five and a half trillion is the base money. That’s all the bank reserves. It’s actually less than five and a half trillion, but all the bank reserves and all the actual cash that they have printed. The rest of it is claims on that. And it’s actually much larger than M2. It’s orders of magnitude larger than M2 if you look globally at dollar deposits internationally and things like that. So you gotta think if they’re reducing the bank reserves, all the money out supply out there is more levered claims on that smaller base. If they cut the, I don’t know how they are gonna restructure the balance if they’re gonna cut it in half and it’s gonna all come out of reserves. But if they cut the reserves in half, basically double the double the leverage on the money supply. The money supply out there would be claims on half the amount of actual money that the government has put into existence, if you can imagine. So that would be uh that would be just my my nightmarish. I don’t think that they can actually accomplish what they’re trying to do. But if they start down that path, I think markets will um will take note.

PHILIP N. DIEHL 13:06

Brad, I’d like to follow up on your comments there. Um you referred to the fact that several years ago the Federal Reserve began taking steps down this path, recognized it had made a mistake once uh markets rebelled, and stepped back and uh began uh raising reserves again. Um I think one thing that we can say about the Federal Reserve at that time was that their approach was pretty pragmatic and has been very pragmatic for the last decade or so as it has attempted to uh deal with these unprecedented challenges that have come in the wake of the uh global financial crisis and the pandemic. Um right now, I think uh there’s an open question about how ideological some of these new members of the board uh are. And uh when you have ideological approaches, sometimes uh you begin to take new transformative steps and you’re unwilling to accept the fact that they are uh in error. Uh oftentimes you uh believe, rightly or wrongly, that uh inevitably these transitions are disruptive. And so you uh you go steady on the course. And if a mistake is made and we do not make a correction like we did uh several years ago, what are the risks for the global economy and for us as individuals?

BRAD CHASTAIN 14:46

Yeah, that’s a good point. And I agree wholeheartedly. Ideologically, I would love to see a reduction in the balance sheet of the Federal Reserve. I do not like that the system relies so heavily on the Federal Reserve and what they do with their balance sheet. So I would like nothing more than to see the balance sheet cut in half at least and everything continually continue to function just the way that it is. Um, unfortunately, I don’t think that’s the reality. It’s kind of it’s uh it’s kind of like um I think Reagan is a good example here, right? Ideologically reducing size of government, reducing deficit, and then left with all of it larger than he started with, because ideologically, I would love to see that as well, but he would he met reality in the world. And I think this group, if they go down this path, I think they’re gonna be met with that reality. And the consequences are substantial because as we’ve talked about the entire many times throughout these uh discussions, that the entire debt-based monetary system has to grow. You have to have it continually expanding in order to refinance debts that come with interest. So more has to be borrowed to pay back what was borrowed plus interest than was created by the borrowing in the first place. And so when you reduce that base that we just talked about, it’s even more levered claims, which require ultimately more risk throughout the system for people to lend, they’re less likely to lend. And then that’s where you get debt crises. Um, because that’s ultimately what 2008 was. Everybody remembers subprime, but what it really led to was debt refinancing crisis throughout the globe where nobody would lend money anymore, and debts could not be rolled over globally, not just in the United States. And there’s different ways that that can happen, and this is um definitely one of the ways that could ultimately lead to uh to that result. So it’s it’s it’s definitely concerning. I don’t think, to be clear, I don’t think they’re gonna come even close to that. The question is how much do they try and how do markets um respond as they try?

MIKE BARNES 16:48

Philip, I want your opinion on this. Uh, we’ve learned through history that we’re supposed to pay attention when the president takes office in the Oval Office. What’s gonna happen in those first 100 days? Is it similar with the chair? Do we need to be watching the summer to see what happens big, or is it more of a long-term view, and we need to watch that as you look at history?

PHILIP N. DIEHL 17:09

I think it’s both in this case. I think uh this chairman is gonna be focused on uh less on interest rates because he won’t have a majority of the board when he comes on. I think he’s going to have some vocal support that is already on the board. There may be a few others uh in the regional banks who uh read the tea leaves and begin to open their minds about the possibility of lowering interest rates, but I don’t think he’ll have the seven votes he needs on the 12 uh member committee to make those changes. However, setting interest rates is not the only really important role of the Federal Reserve. And just like Brad said, uh they have other responsibilities uh related to uh controlling the balance sheet, and that’s going to be a very important uh set of decisions as well. And also the Federal Reserve is the nation’s biggest, most important bank regulatory agency. And uh and we’ve heard uh a lot of discussion from um from the uh recent members of the committee uh who’ve been appointed uh who are interested in uh undertaking a deregulatory approach to the banks and the banking system. And so the decisions, I think we’re gonna see a uh a real focus on bank regulatory policy uh in the near term. Uh the uh during the confirmation hearings with uh Kevin Walsh, he discussed uh the need for a regime change at the Federal Reserve, and it wasn’t really clear exactly what all he meant, but uh I think we can count on bank regulatory policy uh being one of those uh changes.

MIKE BARNES 19:11

Brad, do you agree we need to be kind of far-sighted and not nearsighted as we watch what Warsh does?

BRAD CHASTAIN 19:18

Absolutely, yeah. I mean, it the markets are going to react day to day to news. So what we consistently do is turn back to what is the overall trend? If if we’re moving in a certain direction, what does that look like five, ten years down the road? Not necessarily what decision gets made today or tomorrow, but but a lot of times what you see is that the decisions that are made today or tomorrow, they’re really pointing towards what is being done on that long-term trend, whether it’s the tariff rates or an interest rate policy or um central bank rebalancing of assets and anything like that. You see those day-to-day fluctuations where sometimes they’ll do one thing versus the other. But um when you really look get behind the strategy that they’re using for any of those short-term decisions, they really do kind of point the direction of where we’re headed long term.

MIKE BARNES 20:11

Sounds like right now we need to pay attention to the hawks and the doves and who gets the headlines. Brad Chastain and Philip Diehl, thanks so much for joining me today. Thank you, Mike. Thanks, Mike. That is all the time we have for today’s episode. On behalf of all of us here in the U.S. Money Reserve Studios, thank you for tuning in. If you have any questions or you want to learn more about today’s episode, you can call the number in our episode description and speak with one of our friendly account executives. They will be more than happy to answer any questions you may have about precious metals and the strategic role they can play in achieving a secure and comfortable financial future. I’m Mike Barnes. We will see you next time on America’s Gold Authority Podcast.