What would happen if Trump fired the chairman of the Federal Reserve?

BarcelonaOn Wednesday, US President Donald Trump He denied in a press conference that he planned to fire Jerome Powell., the chairman of the Federal Reserve (the Fed, the US central bank). That same morning, several media outlets such as Bloomberg and The New York Times They had published that Trump had a draft letter to send to Congress to oust Powell, which led to an immediate drop in the dollar on the foreign exchange market and put the US stock market in the red. Only with the president's denial, a few minutes after its publication, did the situation in the markets normalize.

Powell took office in 2018, having been appointed by Trump himself during his first term and approved by Congress. But, months after the appointment, Trump was already very critical of Powell, whom he repeatedly disqualified. because it did not lower interest rates, a measure that—according to economic theory—would have boosted consumption and economic growth, but at the same time would have increased inflation. When Joe Biden took office, Powell was reappointed for a second term. has raised the tone of his attacks against the Fed chairman —now accusing him of carrying out renovations at the Fed headquarters to install a rooftop garden and luxury amenities, something Powell denies—and has repeatedly stated that he wants to fire him. The fact that the Federal Reserve is a public institution, but independent of the government, means that the US president constitutionally lacks the power to remove him, no matter what Trump said he would do. Until Wednesday, the markets hadn't paid much attention to the US president's rhetoric, but when the media began to report concrete plans from the White House to oust him, they quickly reacted until, shortly after, Trump said he didn't want to dismiss him.

Now, what would happen if Trump managed to oust Powell and put someone closer to him at the helm of the Fed? Views vary, but the initial shock to the markets would be severe.

The importance of the Fed's independence

"There is sufficient historical evidence to show that the independence of central banks is a condition for having a rigorous financial system," explains Xavier Freixas, emeritus professor of financial economics at Pompeu Fabra University. The fact that a country has a central bank that is too controlled by the government is a sign that it has a system more similar to that of a "banana republic" than a developed economy.

Thus, if Trump were to oust Powell, not only would it seriously call into question the independence of the Fed, but there would also be the political derivative that the president can bypass Congress, which directly conflicts with the separation of powers that—as in all democracies—imposes the US Constitution and at the same time directly intervene in an agency.

The Federal Reserve has a dual mandate: to achieve full employment in the labor market and keep prices in check. The fact that it is an independent entity from the government is precisely intended to prevent the interests of the executive branch, or even the personal interests of a billionaire like Trump, from influencing the institution's policy. According to Freixas, the loss of independence and the fact that Trump wants someone to lower interest rates—an inflationary policy—would mean that, with a new president aligned with the White House, prices in the US would rise more over time than they would with an independent Fed.

The other danger for the US would be the role of the dollar as a global reserve currency and safe haven, and, by extension, of US public debt. "There is a competition between currencies" to act as a safe haven, the UPF professor recalls, so a portion of the dollars would very likely be converted into euros, Swiss francs, yen, or pounds sterling, especially if inflation in the United States began to rise and, as a result, dollars lost value faster than other currencies.

The dollar's loss of value due to inflation and falling demand would also push up the cost of federal government debt, because much of the dollar's role as a safe haven currency is channeled through the purchase of US Treasury bonds. This allows the US government to finance itself today at a very cheap price despite being heavily indebted, but the fact that it doesn't have such a strong currency or an independent central bank would make investors hesitate.

Deutsche Bank speaks of a "collapse"

In response to Trump's tirades against Powell, this week Deutsche Bank's search engine sent its clients a note signed by the bank's director of foreign exchange markets, George Saravelos, in which he asserts that the dismissal of the Fed chairman could lead to the "collapse" of US debt and the dollar. Fortune.

"We believe the market reaction would be significant," says the Deutsche note on a hypothetical Powell dismissal. "The empirical and academic evidence on the impact of the loss of central bank independence is clear: in extreme cases, both the currency and the bond market can collapse while inflation expectations rise," adds the note, which also points to an "erosion" of institutions.

However, Saravelos was interviewed by Bloomberg on Thursday and said: "As we approach Powell's departure date, the most extreme risk and the risk of threat to the Fed should diminish."

The risk of collapse mentioned by Deutsche Bank is also due to the dollar's loss of value becoming a self-fulfilling prophecy, and as it loses value, more and more people will rush to exchange their dollars for other currencies, further accelerating the fall in the hotel's price. This situation, possible on paper, is very unlikely to occur, according to Freixas: "The Fed is always very quick to react and has mechanisms" to intervene in the markets and prevent a dollar collapse.

However, for now, these mechanisms should not be used. Trump continues to insult Powell (on Friday, he called him and the other Fed governors an "idiot"), but without mentioning firing him.