One of the sub-plots of the last twenty years has been the growth of “derangement syndromes.” It started with Bush Derangement Syndrome at the start of the century, morphed into the far more powerful Trump Derangement Syndrome, took a side trip to the other side of the Atlantic with Brexit Derangement Syndrome, and then turned into Tariff Derangement Syndrome. The basic symptoms are always the same. Some fairly minor, and probably not even very radical reforms, get reframed as an existential threat to the economy, democracy and even civilization itself. We are now seeing the latest example. Warsh Derangement Syndrome, named after the new Chairman of the Federal Reserve, Kevin Warsh – and for investors it is likely to prove the most expensive yet.
To listen to some of the criticism, you might think that the Fed was now run by a cross between The Terminator and Chairman Mao
The new Chair of the world’s most powerful central bank has certainly started with a flourish. Within a few weeks of taking over from the embattled Jay Powell he has embarked on a series of reforms of the way it operates. He has rolled back “forward guidance,” a policy of preparing the market in advance for changes in monetary policy. He has hinted at cutting back the number of policy meetings from eight a year to six. And he has hinted artificial intelligence may be such a transformative technology the central bank may have to look again at the way it forecasts inflation There may well be more to come. Warsh has created a committee of experts to advise him on further changes to the way the Fed operates. Its members include Marc Andreessen, perhaps the world’s most successful venture capitalist; Doug McMillon, the former chief executive of WalMart; and Britain’s Lord King, the former Governor of the Bank of England. We will see what they come up with. But they are hardly swivel-eyed, Fox News extremists. Indeed, if you wanted some help with deciding how central banking should evolve, that seems like a pretty good selection of people to consult.
It is hard to see how any reasonable person could disagree with much of what Warsh has had to say so far. Most people agree that while “forward guidance” may have looked good in the textbooks, it didn’t really work in practice, and it made it too easy for Wall Street to get ahead of the Fed. It is hard to believe anyone seriously thinks holding slightly fewer committee meetings is the end of the world. And given the US is spending $700bn-plus a year, or 2.5 percent of GDP, on AI, by any measure the biggest capital spending boom since the railways were built, it would be odd if it didn’t have some impact on productivity and prices.
And yet, that hasn’t stopped the hysterical criticism. “There is a new potential threat to the economy,” according to Mark Zandi, the chief economist at Moody’s Analytics. “My concern is that policymakers are unwilling to provide even a modicum of forward guidance – or a broad sense of their reaction function.” The Fed has “gone wacko,” according to the economics editor of the Financial Times, while his approach is “deeply flawed” according to Bloomberg’s Opinion section. The list goes on and on. To listen to some of the criticism, you might think that the Fed was now run by a man who was a cross between The Terminator and Chairman Mao, and that the sooner you got out of American equities, and the dollar the better. He is about to bring the whole system crashing down.
Well, perhaps. But in reality, it does not seem very likely. Sure, some of President Trump’s criticisms of Warsh’s predecessor Jay Powell were over the top. And yet, it is not as if the Fed had been doing a fantastic job. Its main job is to keep prices stable. But inflation peaked at above 9 percent in 2022 and had remained stubbornly higher than forecast. The balance sheet has exploded as quantitative easing – otherwise known as printing money – has been tried again and again. True, growth has been strong, and unemployment has remained relatively low. And yet, it would be hard to argue the management of US monetary policy was completely perfect, or that no changes were necessary.
In reality, Warsh has made a respectable start. Setting out the path for interest rates made it too easy for the banks to make money. Alan Greenspan, probably the greatest Fed Chairman of recent times, often caught the market off guard. “If I seem unduly clear to you, you must have misunderstood what I said,” was one of his more famous remarks. The idea that central banks should prepare investors for every move in interest rates several months beforehand is a very new one. There is nothing wrong with going back to the old system of keeping them in the dark. Likewise, fewer committee meetings, and so more stability in rates, may well be a good idea. Perhaps most of all, bringing in a group of experts, from industry and finance, as well as central bankers from other countries to figure out if the Fed needs reforming is perfectly sensible. We will have to see what they come up with of course. But AI may well revolutionize the productivity of the American economy. If it does, interest rates may need to remain lower, since there will be little risk of inflation because the chatbots will transform the supply side of the economy.
Warsh needs to distance himself from the Trump White House, and make it clear the Fed will remain fiercely independent. And of course, you can of course agree or disagree with any of the reforms he has hinted at so far. But Warsh’s critics are acting as if the world is about to end. The trouble is, that will prove very expensive. Anyone selling American bonds or equities because they think he is about to destroy the economy, ruin the dollar, and let inflation rip, is likely to end up a lot poorer. In reality,of all the derangement syndromes, this is without doubt the most, well, deranged.
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