Destabilizing the Fed: Trump Is Right

The independence of central banks is destined to become a relic of the past.

It is certainly the successive blows, increasingly frequent, of the President of the United States that threaten it. But in fact, they have only themselves to blame: it is their own actions that now drive governments to this major reassessment. Keynes himself had become disillusioned: he who, in his Treatise on Money (1930), had theorized the natural rate of interest, the supreme weapon of central banks allowing for a balance between savings and investment so as to achieve an economy free of both inflation and deflation. He who had been a staunch defender of central bank independence—meant to wield their powerful lever in complete serenity—reversed course in 1936 in his General Theory, largely prompted by his disappointment at the manifest failure of those very institutions to overcome the Great Depression.

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Keynes was therefore the first to admit that the competences of central banks were illusory, introducing a fundamental notion still relevant today: the “animal spirits,” which are nothing more than the inclination of individuals toward risk combined with the confidence (or lack thereof) they place in the future. Yet central banks came back into fashion in the 1970s and early 1980s, having successfully tamed the almost uncontrollable inflationary shocks that had so deeply scarred that era. For central banks, this period inaugurated their golden age and consecrated their independence from political powers.

Great charismatic figures such as Paul Volcker and Alan Greenspan (in the United States) or Hans Tietmeyer (in Germany) could not, after all, have their credibility undermined by petty politicians who would not have hesitated to take them hostage in the service of their short-term calculations. And yet, their true hour of glory was owed to Bill Clinton and Tony Blair, who enshrined them as Grand Commanders. To give credit where it is due, these now-untouchable ultra-technocrats produced what has come to be known as the “Great Moderation” of the 1990s, a happy period of strong growth and nonexistent inflation. These experts were thus expected to reign in complete independence, beyond all reach, almost above the fray… except that the implosion of technology stocks (1999–2001) and the global financial crisis (from 2007 onward) brought them back to reality.

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Indeed: the animal spirits so vividly described by Keynes disrupted their plans and forced them to get their hands dirty. The coup de grâce was delivered by the great Hyman Minsky, who did not hesitate to break into their ivory tower. Almost unknown during his lifetime (he died in 1996), having based his research on the causes of financial crises, he gained posthumous fame during the implosion of the subprime mortgage market. Never mentioned—even in passing—by the press during his life, The Economist cited him more than 30 times in 2007 alone!

Minsky’s total lack of visibility stemmed from his métier: the study of crises. At the time, the vast majority of commentators, across the spectrum, considered financial markets omniscient and central banks the ultimate arbiters. Since modern economies were presumed to have conquered their demons, any crisis could only, by definition, prove temporary and have a limited impact on the economy. It was in this context—marked by an almost absolute denial of the destructive potential of markets—that Minsky developed his financial instability hypothesis.

Keep in mind this constant revealed by Minsky: economic turmoil arises from and is caused by periods of prosperity. He described contexts in which households and firms throw themselves frenetically into borrowing without even having the liquidity to cover the interest on their debts, justified only by speculation, banking on an uninterrupted rise in their assets. Such a phenomenon of collective contamination inevitably weakens the financial system as soon as interest rates tighten, a seemingly minor incident occurs, or even a simple spark ignites. The overexposure of these investors—who use massive leverage in the hope that valuations will only rise—further exacerbates the fragility of the entire edifice.

Prosperity, in other words, was nothing but illusory, as Keynes had foreseen, and central banks proved incapable of restraining the infamous animal spirits. It thus turned out that this supposed economic stability—allegedly the fruit of central bank action—carried within itself the seeds of instability, for Minsky’s insights show that periods of great fragility merely echo periods of prosperity. From then on, central banks—and we along with them!—became “addicted” to the infamous “QE,” which are nothing more than liquidity injections meant to oil the wheels and rekindle inflation and economic growth.

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Except that these torrents of liquidity mainly had the effect of creating, in turn, other bubbles: real estate, surreal stock market valuations, absurd cryptocurrencies, and obscene inequalities. They have only themselves to blame today if they—central banks—are in Trump’s crosshairs. They are out of ideas and, in some respects, remind me of the bureaucrats of the Soviet Union! Central bankers no longer know which direction to take, nor even whether their actions and instruments remain effective. Their single refrain, echoed by their defenders, is that any questioning of their independence will inevitably have grave repercussions.