Turning the Page: The First Meeting of the Warsh Fed

MIKE BARNES 0:10

Welcome to America’s Gold Authority Podcast. My name is Mike Barnes. It is transition time for the Federal Reserve. First big meeting coming up in the middle of June. What’s going to happen? Let’s talk about that with a couple of experts. Brad Chastain and Philip Diehl join me now. And Philip, let’s start with you because as the 35th Director of the United States Mint and President of U.S. Money Reserve, you know about being in a big job in Washington. What is Kevin Warsh going to face here in the middle of June with that first meeting?

PHILIP N. DIEHL 0:42

Well, it’s going to be really interesting to watch how he handles the situation he faces. The president has made very clear that he wants the Federal Reserve to uh lower interest rates. He really wants to see 10-year rates fall in reaction to a lower federal funds rate so that mortgages, credit cards, and uh business loans, car loans uh all uh fall, uh the rates fall and become more affordable for people. And Chairman Walsh, in uh his public statements and in his testimony, has both before and after confirmation has made it clear that he believes he can lower interest rates because AI is gonna give him the room uh to lower rates uh because of higher productivity that’s going to lower inflation. Uh of course we haven’t seen that yet. Inflation is headed up, and so here in this very first meeting, he’s probably gonna face a situation in which he is gonna have to make a statement as the Fed and actually probably vote as the chairman of the Fed uh on this issue. And it’s pretty unusual for the chairman of the Fed to dissent from the majority of uh the FOMC. And so we’ll we’ll see what he does. Uh my guess is that he is going to vote to lower interest rate, but be on the minority side, and uh therefore interest rates will uh remain where they are now. Uh but what happens beyond that uh in terms of the chair is anybody’s guess, and the betting is that interest rates is are going to rise by the end of the year.

MIKE BARNES 2:33

Brad Chastain saying inflation is the problem. I know it’s a nine-letter word, but it’s like a four-letter word for people in Washington right now. How’s Kevin Wars going to fight that if he’s gonna lower interest rates? It’s kind of a do-or-die type of thing.

BRAD CHASTAIN 2:47

Yeah, it’s a it’s a good question. Um, because this, you know, a lot of times people throw inflation into one bucket of if inflation is high, you just automatically raise rates and then that stamps out demand and so forth. And that’s a much easier decision to make when it is demand-driven inflation. So if the economy is booming and there’s a lot of demand, and that’s really driving productivity and prices higher and things like that, uh, and then people are reinvesting, they price higher prices, people produce more, and then eventually you have supply catch-up and so forth. You can slow that down potentially by, especially pre-2008, it was even more effective, but um slow it down by raising rates and stamping out the demand. The issue, of course, now that makes this much, much more difficult is you’re you’re battling a supply shock-driven inflation with supply disruption. And so raising rates actually makes it more expensive for businesses to expand production and meet that supply demand. So while they can presumably stamp out some of the demand side to bring supply and demand back into balance, you actually hurt the longer-term cure, which is we need supply chains functioning, we need more productivity that he hopes to get. So it’s it’s hard to say that it’s going to really have the effect and solve a longer-term problem if they in fact do raise rates. Um, right now, given the geopolitical environment globally, it is going to be a uh a much trickier situation to get under control um without more of the conflict resolution parts taking place.

MIKE BARNES 4:29

Philip, I hate to call this a no-win situation for Kevin Walsh, but historically he’s been known as a hawk. And I know you love talking about hawks where higher interest rates suppress inflation. Which way does he go?

PHILIP N. DIEHL 4:42

Yeah. Yeah, this encapsulates a debate I’ve been having with my son. Is he a hawk or is he a dove? And um and I think what we’ve seen in the past, he has a record because he had been on uh on the board back during the uh back during the financial crisis and and then early in uh Obama’s administration, President Obama’s administration, and um he sort of switched sides uh between those two administrations. He was a uh a dove at the beginning of the financial crisis. He uh voted for QE1. Uh then he voted reluctantly for QE2 uh once we got into the Obama administration. But shortly after that he left the commission and and really uh talked a lot a lot like a hawk. Uh now here he is coming in as chair and he’s talking as a dove. Um and of course the president has has appointed him as a dove. Uh it’ll be interesting to see how he plays this because uh depending on how long, I think he’ll be given a leash, but it’ll probably be a short leash in the market, uh, where people expect him to vote as a dove. But if inflation continues to go up and he continues to vote and even press harder than just voting for lowering interest rates, then I think that’s going to raise questions about the independence of the Fed, whether or not the president has been able to, through his appointment of a chairman who follows his policy desires, is uh is really uh making some headway in his attempt to uh reduce the independence of the Fed.

MIKE BARNES 6:32

Brad, this isn’t the first time that the chair of the Fed has been in a proverbial hot seat where it’s tough for him to do his job because there have been other times in the history of the United States where the economy, financial situation wasn’t exactly great, and it was a lot of time up to the chair to kind of fix that, correct?

BRAD CHASTAIN 6:50

Yeah, that’s happened a number of times. I mean, the most notable that people are familiar with is the the 70s into the 80s, right? Um it’s the Arthur Burns and Paul Volcker um situation where Arthur Burns was failing to stamp out inflation, uh, had was working on some older economic models uh of uh productivity, and uh that kind of lends itself to what Philip just mentioned around AI productivity as well, where um Burns was looking at the maximum output sort of of the economy. That that con the productivity could theoretically be quite a bit higher. And so they ultimately were focused on productivity gains being able to offset inflation, and that never came into uh came into play. And then it wasn’t until Volcker got in that had to really ramp rates up significantly, actually cause recessions to get that demand side uh down to stamp out inflation, which then ultimately paved the way towards more reaganomics, which is more the supply side, to start getting the supply side up. But that probably would never have been as effective as it ultimately was, that kind of paved the way into the later 80s, 90s, and even to throughout the 2000s if inflation had not been brought under control first.

MIKE BARNES 8:07

Brad, you’re sharing some great history. Now we have to look forward to the future. Philip, what’s the future gonna hold with Kevin Walsh as the chair?

PHILIP N. DIEHL 8:17

Well, he doesn’t have a majority. When you count out the votes, uh the 12 members of the FOMC who cast votes on interest rates, he doesn’t have a majority. He has uh three clear votes, including his own. Um and he’ll have uh the former chairman uh uh sitting as one of the votes. Uh he has tremendous informal uh authority with the other members. He knows the institution backwards and forwards. The staff is close to him because he’s been in charge of the uh of the staff over all these years. And he will be uh a strong vote for maintaining the independence of the Fed and responding to the markets as he sees them, as they’ve done for uh the last decade. And so they’re gonna be very evidence-based, not ideol ideology or political based. So the new chair, Chairman Walsh, has a real challenge to get the seven votes he needs in order to uh to move interest rates downward, uh, especially because the pressures are going to be uh for moving upwards. And the fact of the matter, even if he does change the FOMC’s vote and uh and is able to get the seven votes to lower rates, that doesn’t mean that 10-year rates are going to decline. In fact, what we saw when the Federal Reserve uh year or so ago, year and a half ago, uh lowered rates, uh 10-year treasuries and other rates went up uh because the market did not believe that interest rates, that uh inflation rates were truly under control. So we could say see that happen again. Even if the Fed lowers interest rates, markets could say, no way, uh inflation continues to be a problem, and we don’t believe in the future that uh uh the inflation situation is going to warrant us lowering rates. So he’s really got a tough task ahead of him.

BRAD CHASTAIN 10:31

And what really matters is real rates, and real rates have actually been falling since 2022. I mean, they’ve been bouncing around, but the the higher rates today are inflation-driven um response. And so when you when you look at real rates actually having been coming down, they’re they’re moving in the direction that um that Warshore President Trump would like, just not in the nominal headline uh number there. So um so I agree. I think markets would probably respond um, you know, uh to a cut in the expectation of higher rates in the future. But I think what’s really going to be interesting, we’ve talked about it before, is what they do on the balance sheet side, because uh the the rates get all the headlines. Uh the pre-2008 world was all about rates post-Volcker. Um, and so that’s still what the financial world focuses on. But he’s talked about a regime change at the Fed. I think a lot of that probably has to do with the balance sheet and the way that they coordinate with Treasury to um to influence rates. And I think the the actual rates that they set are going to be more meaningless than they actually have become in post-2008. I mean, the Fed even Ben Bernanke set the stage for this long ago, back in about 2011 or 12. He said, outright said, there’s nothing magic about the Fed funds rate. It’s this policy rate that indicates the monetary stance, but there’s so many other things they do. It’s not the rate, it’s all the other things they do around that to support it with their balance sheet and with uh some of the facilities at the Fed uh Federal Reserve that provide money into different markets and things like that. So that’s what’s gonna be, I think, a lot more interesting. So um from Warsh’s view, I can kind of see if they think they’re gonna shrink the balance sheet, then that is very restrictive for markets. Um that’s much more restrictive than cutting a rate, in fact, because it makes it where banks can’t lend as much, um, whether they want to or not. They don’t have the reserves to be able to do that in the post-2008 world that is built on reserves, not rates. Before 2008, they held barely any reserves. Moving a rate changed how much banks could lend to one another. And that’s just not the world we work in. And I don’t think you can apply that. So I can see how he can actually be thinking in his mind that cutting rates will help because it helps with federal deficit, with all the short-term borrowing, less interest going out into the uh being paid out into the economy by the uh by the federal government, which is ultimately stimulative, and restricting banks’ ability to lend and create credit is um is very restrictive. But this is a a world that I think if we see that, we’re gonna see a lot more volatility because it’s not the the lens that a lot of the financial world views how things work with. So there will be a lot of adjustment there and remains to be seen whether what the what the outcomes are. And we already know that when reserves shrink, um, it is very disruptive in today’s system um for markets. So um it’ll be interesting to see. And I think the way that people talk about the Federal Reserve, you know, five years from now, is going to be very different than the way they talk about it today in terms of what actually matters and what’s going on with uh with their policy.

PHILIP N. DIEHL 13:53

Yeah, I’d like to follow up on uh what Brad has said here, and I I think he’s exactly right that uh the interest rate question is going to draw most of the attention, but it’s a sideshow. Uh because partly because uh I don’t believe the FOMC is going to lower rates uh in the face of higher inflation. The president is going to be unhappy about that, uh, and that’s gonna draw most of the media attention when the real show is going to be on the balance sheets and what’s done on the balance sheet. And one thing that’s really important to understand here is that the Federal Reserve chair has a much more authority and power over decisions on the balance sheet than he does on uh interest rates. Uh he uh he controls the staff, he controls the agenda uh for the meetings, he controls the information that’s able that uh goes to uh the FOMC members uh uh in preparation for those meetings. And so he has a lot more authority and flexibility and informal power in order to get his wishes on the balance sheet. And it’s very clear to me that when he talks about regime change, he is really talking about uh the balance sheet regime. I think probably that’s where he’s going to be able to make his case to the White House that, you know, I uh I’m not making progress yet on interest rates, but I am making progress on balance sheet uh and uh fighting inflation that way. I think he has uh an overly optimistic view of how much control he actually has on the balance sheet, on how far he can go with restricting the balance sheet. Because as Brad mentioned, uh there there are constraints for how far he can go, and the market can react very strongly in such a way that forces his hand to loosen up. And we’ve seen that occur a couple times in the last several years where the Federal Reserve has made uh has talked about you know tightening the balance sheet and has begun to do so, and then in global markets has been forced to back off. So uh we’ll see how well this regime change goes. This administration likes to talk a lot about regime change, and and now they’re talking about doing it to one of our most independent institutions. And uh and I just think there’s a an uh underappreciation for how strong the market can react and constrain the actions of the Fed.

MIKE BARNES 16:48

I think a lot of people have seen what the price of gold has done over the last six or seven months. And Brad mentioned the word volatility. Well, does the balance sheet apply to this at all, or is it just interest rates, or are we just looking too far beyond that? And it’s still the war in Iran and several other factors, Brad, that we really need to concentrate on.

BRAD CHASTAIN 17:07

No, it it does play a role because what and and they’re they’re all related. So when the balance sheet shrinks, what ultimately happens is it drains liquidity from markets, the availability of money. The war has done the exact same thing, where money is not flowing in the same ways that it once did. It’s affected uh the trade surpluses of countries like Japan and even the oil exporting nations that have traditionally been heavy buyers of US assets. And when that liquidity is drained, that has a negative impact on all assets. So they’re very, very much aligned. On the other side, the solution to that is always more liquidity. So once it gets to the point where things break, that’s where Federal Reserve central banks back off and they reverse all of that. They start with things like quantitative easing, which they’re already doing in the United States after they stopped their quantitative tightenings and started doing it, and they’re calling it revert reserve management purchases at this point, where they’re buying short-term uh debt, but they’re they are gradually expanding their balance sheet to support the treasury supply. And so those are the things, and but it’s very small. When things break, they go big. And that is what gold responds to very, very heavily. And the more we tighten, the more debt, the more interest that gets created, the more liquidity and money is required to roll over that debt. Eventually you get into a refinancing crisis. It’s ultimately what 2008 is. Everybody reverses course, and the money printers, um, so-called not official money printers, but on the balance sheets of the financial system, um, expand, and that’s a long-term bullish case for gold. So that’s why we say this debt-based monetary system is just an underlying long-term catalyst for gold that is not changing, it’s only accelerating.

MIKE BARNES 18:56

Philip, do you agree? Is this the case of where gold is going to go up no matter what, no matter what Kevin Warsh does with the Fed?

PHILIP N. DIEHL 19:04

Well, of course, everything that goes up must come down. And uh so I’m not uh saying that gold is immune from gravity. But what we have here is a unique set of forces that almost all of them have aligned to support gold. And I mean, one of the uh Brad alluded to this, and that is sovereign debt. Sovereign debt is over the long term really one of the most powerful drivers for why I believe uh gold is headed up for the long term. And over the shorter term, I think it’s headed up too, because there’s really two scenarios, there’s three scenarios here. One is the Goldilocks solution, and that is that we’re able to thread this needle uh and uh this economic needle and avoid either a recession or high inflation. And really, I don’t see that happening. I don’t think that is a credible scenario. So I believe over the next uh 12 months, we’re gonna see either inflation take off, and uh because the Federal Reserve does not commit to fighting it uh by biting the bullet and raising interest rates, irrespective of what the White House wants, uh, or we’re gonna see them uh do what uh what Volcker had to do in the 70s in the 70s and 80s, and that is uh really choke off the economy for a period of time uh and cause a recession. And I don’t think it will be a uh uh a light uh recession like what we’ve seen recently. I think it will be a significant one. And in those scenarios, you look at what gold’s performance has been in both recessionary periods and in uh inflationary periods, and in all five of the uh recessions of the last 26 years, gold has outperformed stocks. Uh either that it’s gone up when stocks has have gone down. I think maybe there was one exception where uh stocks went up maybe in 1990, uh uh while uh gold went up much higher. But in all the other situations, gold has risen in price and stocks have fallen. And of course, in 2007 through 2009 during the Great Recession, uh it was a huge difference. And so if we see a recessionary situation, uh we’re going to see gold far outperform stocks. Also during the most uh recent inflationary period between 2001 and 2005, gold outperformed the SP 500 two to one, rose 174 percent versus uh or 154 percent versus 74 percent, and that really runs contrary to conventional wisdom. Uh uh so I think we’re in a situation, a similar situation here where uh gold is likely to outperform uh stocks by considerable margin by under either scenario.

MIKE BARNES 22:29

I think that you’ve both shown that there are things to watch out for, but that the future of gold looks good, but we also need to watch out for what Kevin Warsh does as he takes over at the Fed. Brad Chastain and Philip Diehl, thanks so much for joining me today. Thank you, Mike. Thank you, Mike. That’s 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’ll 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’ll see you next time on America’s Gold Authority Podcast.