Adam Tooze on Incoming Fed Chair Kevin Warsh (Plus: Michael Jackson) | Ones and Tooze Ep. 240

Hi Cameron.

Yeah, I would say that Warsh is a symptomatic figure. I mean he's not a central banker in the mode of a Ben Bernanke or Janet Yellen. In other words, a heavy-duty econ technocrat nerd, monetary policy or monetary economics star. He is a smooth, very well-connected Republican insider and he's a lawyer. So he's more in the Jerome Powell kind of vein. He was born in 1970 so he's younger than me. He attended Stanford and Harvard Law, which in itself may be telling. He then moved to Morgan Stanley and then with the Bush presidency in 2002 he was appointed as special assistant to the president for economic policy and then executive secretary to the National Economic Council. I think he was too young at that point to have a commanding role. At least at that stage the Republicans weren't appointing people of his age to say the senior roles. But in those positions he played a key role in sorting out some of the accounting scandals of the early 2000s. But then in January 2006, Bush nominated Warsh to serve on the Federal Reserve Board of Governors. And at that moment, he was the youngest ever Fed Governor when he was appointed. And between 2006 and 2011, he was really the kind of markets liaison, the markets fixer man for Ben Bernanke because he was in the thick of the 2008 financial crisis and his experience at Morgan Stanley was widely considered to be important. And at this point a sort of doctrinal Warsh begins to emerge which is a man who is preoccupied essentially with private sector solutions, with problems of moral hazard and as such therefore is entangled in all of the difficult and in the end in many cases disastrous decisions that were taken by the Fed in 2008. The first initial move, namely to stabilize the situation by way of a private sector deal between JP Morgan absorbing Bear Stearns and then it seems that Warsh was reluctant to say the very least to support Lehman with catastrophic consequences when Lehman actually then failed and then in '08-'09 he was responsible for brokering the deals that were done that recapitalized the American banking system which are in some I think by many people regarded both as of course dubious from a social equity point of view or from a democratic accountability point of view but highly effective in terms of actually recapitalizing the American banking system by contrast with what happened or rather didn't happen in Europe where the European banks were not recapitalized. He was then however passed over in 2009 for the New York Fed chair position which went to Dudley who came from Goldman Sachs and was more of an economist and then progressively he falls out of favor with Bernanke. We'll talk more about the QE incident in a moment and through the 2010s begins to circulate outside the Fed now in private finance on the one hand and in conservative intellectual circles centered on the Hoover Institute at Stanford and it's against that backdrop that he was then nominated. He more and more prominent really in conservative conversations in the 2020s and so it's no surprise really that he emerged as a pick for Trump. It's, I think, not unfair to speculate that this isn't purely a professional choice on Trump's part. I mean, Trump is willful and typically personalistic in his choices. He famously picked Jerome Powell over Janet Yellen because he just didn't think a small nerdy woman was suitable as a Fed chair and he thought Jerome Powell, and I'm just quoting here, looked the part. He came out of central casting and this is something he said about Warsh as well. It no doubt helps that Warsh through marriage is connected to the core of Trump New York clique. So he is the son-in-law of Ronald Lauder, that is Estée Lauder, that fortune, and Lauder is after all one of the people that we think may be pushing the crazy Trump moves on Greenland because apparently Lauder has some interest there. So it's not for nothing that Elizabeth Warren in the hearings that were quite rough for Warsh referred to him as the president's sock puppet in monetary policy. So he's a man with experience, relevant experience, with a track record, with opinions, with political connections and with family money and the family connections that seem during this day and age in Republican politics. It does seem worth noting that he would be the wealthiest Fed chair in history.

But now, yeah. I mean, and there's an issue around the financial disclosure as well because his wife's wealth is presumably immense. These are the people that, you know, these are really high rolling philanthropy we're talking about here. And yet Warsh can still claim that he has a connection to understanding the real economy because he grew up not in a wealthy or a spectacularly wealthy household, but rather I don't know, I forget what his parents did. I think it was his dad produced school uniforms.

Yeah. And so he claims that's where his understanding of the real economy comes from prior to marrying into the billionaire wealth of the Estée Lauder family. But to sort of dig into Warsh's views more specifically and how that's come out, I mean I did remark upon a few instances where Warsh did speak out about what the Fed was doing and specifically criticized what it was doing. In October 2010, while he was on the Federal Open Markets Committee behind closed doors, he was very critical of the policies that the Fed had at the time and claimed that the sort of QE tools, the quantitative easing tools that the Fed was using, that the Fed didn't quite understand how those tools worked. And yet, he nevertheless voted for the use of those tools rather than vote against that. And so, I'm curious how to understand that tension there. I mean, is this a matter of institutional loyalty in the Fed about how that works or is this a kind of indication of Warsh's own intellectual or epistemic cowardice when it comes to these issues? And you know, similarly, I noticed another quote where Warsh was talking in 2011 about the Fed's QE efforts and he said the Apple iPhone 5 at the time, iPhone 5 launch would have more economic impact, he claimed, than the Fed's QE efforts. So I'm curious, is it possible to sort of derive what Warsh really thinks about monetary economics, what he thinks about supply side dynamics versus kind of demand management when it comes to running an institution like the Fed.

Yeah, I mean in fairness to him, we should say that he did resign from the board in 2011. He was not in the end he wasn't keen to continue in the second phase. Right. So just to put this back in perspective, there's the shock of '08. There is the desperate scramble to rig a private solution which fails. That's the Bear Stearns stabilization, various other merger talks. And then the Fed swings into action in '08-'09, does the first round of QE, which is when you buy illiquid bonds essentially off people's balance sheets and give them cash in exchange. There is also the recapitalization of the big banks and then the economy fails to take off and there is this second push QE2 which is launched by Ben Bernanke in which seems to perpetuate a regime of bond buying so as to drive down interest rates. People debate we've debated on the show about what the transmission mechanism is so-called how do you get from these kind of central bank operations to real economic effects. Warsh is not entirely wrong to say that the economics profession doesn't have at least one clear very powerful line. There's a whole series of different ways in which it works. Could potentially be working. He wasn't comfortable with this and pulls back and resigns and moves back into private sector into conservative politics in the think tank kind of world the Hoover Institution and yeah so then he's carping from the sidelines and again I don't think it's the I like in fact I've often thought we still haven't really put this together the two histories of American capitalism in this period one is the financialization story and the other one is the emergence of platform economics and smartphones as the next generation of the tech story. I think they're apples and oranges in terms of their economic effects. One is an industrial effect so it's a microeconomic central effect the other one is a macroeconomic push. The huge surge in Apple's valuation after all also benefited a supply chain which reached out to China. So how far these benefits are really for the US economy is an open question. It's quite clear that smartphone launches do send a wave of stimulus through the East Asian economy. As each new generation is launched, there's a retooling of factories and a push. So, you know, it's not an entirely specious remark. But what I think it's really telling about, and this is what we're going to get to more and more as we think about this figure, is the underlying politics. And what's quite clear is that Warsh was willing to though he took some persuading and dragged his feet to go along with certain sorts of emergency action by the Fed in extremis, but then was somebody who believed that these should be reeled back in and there was a slippery slope kind of logic and in the history of the Fed which after all came into existence in 1913 after the last big private sector bailout driven by the original JP Morgan in 1907 that the principle of the Fed was okay. We make a concession to the need to have government in monetary policy and it will maybe have to do crisis fighting but when it does this needs to be temporary it needs to be short-lived and when it's done there needs to be retrenchment and this is this sort of normalization discourse of the 2010s which Warsh becomes an exponent of and I think that's lurking in the background and we'll see that when we come to talking about his statements more recently in the 2020s.

Yeah. So this is another phase in what you might call the post-class Fed. If you think of the modern Fed as having been created by the Volcker shock of 1979 and under Volcker and Greenspan and Bernanke a certain style of Fed policy having been instituted which was interest rate driven relatively arms length and we have the crisis of '08 the immediate bailout QE2 and then as part of QE2 and this package in the 2010s to try and manage this new relationship produced by the huge expansion of the Treasury's balance sheet in treasuries and other sorts of fixed income. This adoption of forward guidance as a key mechanism and this is one of these weirdly subtle mechanisms that economists end up focusing on and giving in at some level kind of surprising. It's very counterintuitive. You think of economists as being to do with the real world. In fact, they operate at the level of expectations more often than not. Right? Because given a rational choice model, how do actors, how do economic actors decide what to do? They hinge their choices in the here and now on expectations of the future. And those expectations are very powerful in changing the choices we make in the here and now. And as far as the bond markets are concerned, the key thing is what do you expect the future trajectory of Fed policy to be with regard to interest rates? Or rather, what do you expect future interest rates to be? And so then to kind of wind this all up into an extraordinary self-reflective spiral in 2012, the Ben Bernanke Fed started adopting this routine habit of the members of the FOMC publishing their own personal forecast of where they expected interest rates to be which of course they have a degree of choice in influencing. They have votes on this. So it's a strange combination of forecasts of the future of the economy plus implicitly forecasts on the voting balance of the body of which they themselves are part. So it's a strange typically claustrophobic self-referential kind of feature of the world of the 2010s. And I think Warsh positions himself as the sort of sound properly conservative figure and says well this is crazy. This is a kind of hall of mirrors. This is a funhouse. I mean, it's worth quoting him a little bit just to get a flavor of the guy because he's, you know, we're going to hear well, he promises we'll hear less of him than we hear of Jerome Powell, but in his current role, he likes people listening to his language, which is quite striking. I mean, he's a sort of quite fine one's almost tempted to say lawyer. I do not find the current Fed policy of data dependence of much real value. We should care little about two numbers to the right of the decimal point in the latest government release. Breathlessly awaiting trailing data from stale national accounts subject to significant subsequent revision is evidence of false precision and analytic complacency. Near-term forecasting is another distracting Fed preoccupation. Economists are not immune to the frailties of human nature. Once policymakers reveal their economic forecast, they can become prisoners of their own words. Fed leaders would be well served to skip opportunities to share their latest musings. The swivel chair problem, rhetorically waxing and waning with the latest data release, is common and counterproductive. Forward guidance, a tool rolled out to great fanfare in the financial crisis, has little role to play in normal times. This is the sort of voice of a kind of neoconservative tonality almost. I think they've been reading too many excerpts from the 18th century. It's kind of like Burke or something like this. And the answer is, well, okay, if the Fed isn't going to do this kind of thing, then it's going to make choices behind closed doors, is it? And so then skeptics in the market ask, well, is it going to become more opaque? And there is a worry I think that somebody like Warsh who's not a technical economist who didn't grow up optimizing dynamic general equilibrium models ultimately thinks of himself as a sort of exponent of a kind of market wisdom will in the end be making decisions by the seat of his pants. And it'll be a matter of kind of market mood on the one hand, or ultra short-run data for pricing, which is really just a kind of ramped up version of the technocracy that we've already got, but dressed up in conservative garb. So, I don't think we quite know what to make of this style yet. And it's going to be interesting to see what it amounts to.

Yeah, I mean I think there are three possible ways of situating this whole independence issue with regard to Warsh and the first is like the classic 1990s economists argument for independence which is actually based on complicated arguments that began in the 1970s about discretionary non-discretionary economic policy and I think he squarely doesn't belong in that that's not his bag that's not where he's coming from. I think then there is this issue of the paradox that you're alluding to of anyone who has any connection with Trump is by virtue of that connection discredited as a representative of any kind of serious institutionalism. But I think a third reading would be to say that the Trump administration is a coalition of different forces. And of course to hold that coalition together, politics is necessary. And one of the forces in the Trump coalition which we systematically underestimated is the kind of sharpened Bannonite wing which is waging a very serious campaign of rollback against the American administrative state. This isn't the DOGE, you know, slashing thing. This is much deeper and it's centered. It's not Elon Musk who doesn't really understand much about government, but it's American lawyers, conservative lawyers, of which Warsh is one, who have been waging a fairly sustained and principled campaign against the development of the administrative state, which they date to the early 20th century. And they date to Woodrow Wilson and the first Democratic administration of the 20th century. And hey, presto, who was it that brought the Fed into being, but Woodrow Wilson in 1913. And so this is Warsh speaking about this in some of his Hoover Institution publications. Modern Wilsonians may be discomforted by my words, but granting boundless power to government agencies to solve the world's problems does not square with my disposition. That's the sort of his high-toned tone. And then in another piece, the Fed has acted more as a general purpose agency of government than a narrow central bank. These are red flag terms in this discourse of conservative assault on the administrative state. And then when you get into the details of his positioning, it gets even more clear-cut, right? Because his argument about the Fed is less to do with financial regulation than the sort of points you're mentioning than the way in which the Feds and central banks generally from the 2010s onwards found themselves pressured including by people like me to take on a much wider agenda of economic policy and more generally and so there's three things that he singles out in the co-authored Hoover publication from 2022. Which are the tentative engagement of central banks with climate change, the tentative engagement of the Jerome Powell Fed with the question of racial inequality in unemployment, and then the highly technical conversation which was about average inflation targeting rather than point inflation targeting. And all three instances of this. And you could add as a fourth element his long-standing critique going back to the 2010s of very large-scale balance sheet expansion and the purchases of treasuries. So again, let me just quote some to give you a flavor. The Fed often presents itself as a humble and technocratic institution hewing closely to the remit. They say they take fiscal policy decisions as given and then react. But it's no longer obvious whether monetary policy is downstream or upstream from fiscal policy. Irresponsibility has a way of running in both directions. You know, and these are the tone. The Enlightenment elevated the role of reason and autonomy in decision-making and Rousseau none conceived of a central bank like ours. Still a fundamental precept of their thinking will be helpful to the modern Fed. A fierce resistance to whims. And those whims then are things like others can adjudicate whether matters of cultural import are in the province of the political class or of civil society. This is the future Fed chair. But the Fed's business it is not. Climate change and inclusion are politically charged issues. People of good conscience have their own views and motivations. Elected officials are tasked with evaluating those. Right? So this is a matter of where does these sorts of judgments fit and they fit on the side of Congress not on the side of the Fed and the cultural war element of this becomes extraordinarily stark when he starts to draw in analogies to other institutions. More broadly, the central bank should consider adopting a principle of institutional neutrality pioneered in the university context and often associated with the Chicago principles. Neither the modern university nor the central bank has a comparative advantage as a social justice institution. They should avoid taking positions on social and political issues unless such matters plainly threaten the core mission of those institutions. The more the Fed opines on matters outside of its remit, the more it jeopardizes its ability to ensure stable prices and full

Employment. So it's this lurching segue, right, from very conventional 1990s central bank independence discourse to free speech on campus debates and you know diversity of opinion discourse that we're very familiar with in the last four or five years in the US. And the Chicago principles are literally a reference to the leadership of Chicago University which adopted this position which was widely seen on the right as a model of anti-woke university governance where the university declared that it wasn't in the business necessarily of making safe spaces, that they would tolerate a high level of viewpoint diversity is the phrase, right, on campus. And what Walsh is doing is creating a kind of analogy between the struggles over university governance and the governance of the Fed. And I believe that may be the first time in the Fed's history that that kind of connection has been made live in the way that he's doing.

You know, I mean, he's set himself up, one could say. He's quite boxed in by this dual positioning. But I do think it's an interesting test case for the coherence of the Trump coalition because this is the language that is being pushed consistently in the struggle over the administrative state. And the cynic might simply say, well, in the end, what this boils down to is license for an alliance between an inflationist populist president and a bond market that frankly just likes to be juiced. Like, you know, there aren't really that many votes in Wall Street for austere monetary policy, right? This is this conservative fallacy that business actually wants a tough governmental hand. It's not true. It doesn't add up. So it could just be kind of a hands-off position, but it's going to be interesting and he will have to after all persuade other board members and he has the reputation that he does. He's young, he's a conservative political toy. He's a sock puppet. He doesn't have the technocratic weight of a Bernanke or a Yellen. And he doesn't have the gravitas and the political heft of a Powell. So let alone a Volcker or Greenspan, nor the kind of I guess wherewithal or penchant for bullying that Trump does. I suppose another method would be to have an appetite simply for bullying others, but I doubt he...