(Bloomberg Businessweek) -- It took President Franklin D. Roosevelt a dozen years to turn over all the seats on the Federal Reserve’s governing board. Donald Trump is in a position to name five governors in just two years, while elevating a sixth to the chairmanship.
Markets are betting that Trump won’t seize on this chance to reshape the nation’s central bank in his own defiant image. So far his picks have been mainstream, and he’s refrained from berating the institution, which has been gradually raising interest rates to keep the U.S. economy from overheating.
Of course, Trump could get more provocative with his three remaining board nominations, particularly if he wants to placate the populist, anti-Fed wing of his own party. And if the Fed’s rate-raising campaign seems to be thwarting his efforts to make the economy grow faster, he could pivot against the Fed’s leadership the same way he went after Chair Janet Yellen during his run for the presidency.
Even if none of that happens, Trump’s remaking of the Board of Governors is stripping it of decades of institutional experience. Danske Bank A/S economists recently calculated that after Yellen steps down in February, the governors will have just 10 years of collective board experience, the lowest number since Ronald Reagan’s second term in 1988.
The rapid turnover could unsettle markets that have become accustomed to gradual, well-telegraphed changes of direction, says Diane Swonk, who runs an economic consulting firm, DS Economics, in Chicago. Even the more seasoned Fed of 2013 managed to freak out investors around the world when a casual mention of a change in asset purchase plans caused what was quickly dubbed a taper tantrum. “To assume the new people are going to learn from all their past mistakes when we’re in uncharted territory is expecting too much from the institution, frankly,” says Swonk. “It could all be benign. But it may not be.”
A key indication that Trump is determined to put his stamp on the Fed is that he chose not to reappoint Yellen, a Democrat, to another four-year term as chair. In contrast, Reagan kept Paul Volcker as chairman for most of his time in office even though Volcker is a Democrat, and Bill Clinton stuck with Alan Greenspan, a Republican. Trump told Fox News anchor Lou Dobbs in October, before announcing his decision on the chairmanship, that he liked Yellen, but added, “In one way, I have to say, you like to make your own mark.”
Trump the businessman does appear to understand the need for an independent central bank. So does Treasury Secretary Steven Mnuchin, who’s a sounding board for Trump on the Fed. A board choice that undermined investors’ confidence in U.S. monetary policy could be disastrous for the president’s agenda. Trump “realized that these appointments matter,” says Mark Gertler, a New York University economist.
So far the president’s Fed picks have been considerably more centrist than his cabinet choices. Jerome Powell, who succeeds Yellen as chair on Feb. 3, was a visiting scholar at the Bipartisan Policy Center before joining the Fed board in 2012. He’s worked as a Wall Street lawyer, investment banker, and Treasury Department official. Randal Quarles, the new vice chair for supervision, is also a former Wall Streeter who put in time at Treasury. Both men were once partners at Carlyle Group, a private equity firm with connections to both political parties. Marvin Goodfriend, who’s awaiting confirmation, is a respected monetary economist at Carnegie Mellon University with deep knowledge of the Fed.
The next choices will be crucial. If Trump wants to assuage Hill Republicans who feel the Fed’s interest rate decisions have been arbitrary and unreliable, he could name John Taylor of the Hoover Institution as vice chair—assuming Taylor would take the job after having been passed over as chair. He’s the leading advocate for managing interest rates according to a published formula (known as the Taylor rule).
If Trump wants to go all-out populist he could name Larry Kudlow, a CNBC commentator and Wall Street consultant who once worked for Reagan. If he wants a politically savvy conservative with a Ph.D. in economics, he could choose American Action Forum President Douglas Holtz-Eakin. A centrist alternative would be Mohamed El-Erian, chief economic adviser at German insurance giant Allianz SE, who is a Bloomberg View columnist. Many other names are in the mix.
Trump also has an opportunity, albeit an indirect one, to reshape the leadership of the 12 regional Federal Reserve Banks. The presidents of those banks sit with the board governors on the rate-setting Federal Open Market Committee, though only five of the presidents can cast a vote at any one time. In recent years the Board of Governors has exerted more influence over whom the regional Feds pick as president, through the vetting process for candidates. This could eventually give Trump’s nominees to the board—and by extension, Trump—more say over who heads the regional banks.
Centralization of power at the Fed increases the risk of groupthink. That danger would be exacerbated if Trump continues to lean away from Ph.D. economists in filling board openings. Academic economists aren’t always right, but they do tend to research their positions deeply and defend them tenaciously. Only one of Trump’s choices, Goodfriend, fits that mold. And only two of the latest six regional bank president appointees have economics Ph.D.s. On Dec. 4 the Federal Reserve Bank of Richmond named as president Thomas Barkin, a senior executive of the consulting firm McKinsey & Co. “You have to have professional diversity, but we’re getting dangerously close to going too far away from professional economists,” says Peter Conti-Brown, a Fed historian at the University of Pennsylvania’s Wharton School.
With inflation and unemployment low and the stock market hitting highs, everyone’s getting along fine. But will the Fed stand up to Trump if it needs to raise rates more than he wants? And if it does, how will he respond? That, says David Rosenberg, the chief economist of Canadian wealth manager Gluskin Sheff + Associates Inc., “is the elephant in the room.”
--With assistance from Craig Torres
To contact the authors of this story: Peter Coy in New York at pcoy3@bloomberg.net, Christopher Condon in Washington at ccondon4@bloomberg.net.
To contact the editor responsible for this story: Cristina Lindblad at mlindblad1@bloomberg.net.
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