Could Donald Trump's power struggle with Federal Reserve create next financial crisis?

Australia Broadcast Center

3 days ago

Physics often has a funny habit of accurately describing human behaviour.
Take Newton's third law that, for every action, there is an equal and opposite reaction.
It's a maxim that could apply to all manner of geopolitical events and upheavals right now from the wars tearing apart the Middle East to Vladimir Putin's disastrous military adventure in Ukraine.
And then there is America.
After just five months in power, US President Donald Trump predictably has driven a wrecking ball through the foundations of American society with his attacks on the legal system, various arms of government, academia and the media.
In recent weeks, he's re-opened an old front from his first term, the independence of the US Federal Reserve and, particularly, its chair Jerome Powell — who, incidentally, Trump appointed.
It's a battle that could have profound impacts on the US economy and, by extension, the rest of the world.
For Trump, this is unfinished business, you might say, after belittling and demonising Powell during his first term for not slavishly following his orders. Now, he's at it again.
This time, however, he has met an intractable force.
Unlike Congress, the Republican party and some in the courts, the Fed boss is standing his ground and refusing, point blank, to bend to Trump's will to immediately slash interest rates.
Late last year, when asked whether he would resign if Trump demanded it, Powell gave an uncharacteristically blunt answer.
"No."
When pressed as to whether he was worried the new president would remove him, he uttered a simple retort, twice:
Unsurprisingly, Powell has been met with a barrage of schoolyard insults from the Commander in Chief — "dumb", "stupid", "numbskull" and "a disaster", to name a few. That's just in public.
With just under a year of Powell's term to go, the president seems hell bent on announcing his replacement within months, possibly sooner, to stymie his power.
The reaction could be severe and ultimately may destabilise America's economy.
Powell threw down the gauntlet to Trump last week in a hearing before Congress.
When questioned as to why the Fed had decided to keep interest rates on hold, the Fed chair calmly sheeted the blame back on the president and his tariff policies.
"We do expect tariff inflation to show up more," Powell said.
That's an eminently responsible course of action. Cutting rates ahead of a potential inflation spike could spell disaster for the US and the rest of the world.
And then there's the potential impact on global growth. Even the vastly reduced proposed impost on China — now set at 40 per cent — is expected to have widespread and damaging consequences.
In the meantime, the president is racing to have his "One Big Beautiful Bill" pushed through the House by July 19. Beyond that date, the whole thing lapses, and the process will need to start all over again.
There are two reasons Trump wants interest rates cut to almost 1 per cent immediately.
The first is that it will lift his approval ratings. But the second is the ballooning US government debt. The annual interest bill on its $US36 trillion debt is now bigger than America's defence spend.
Cutting rates would dramatically reduce the interest bill and make it appear as though the new administration is successfully managing the economy.
Given Trump's signature Big Beautiful Bill — with its tax cuts for the rich and increased spending — will dramatically blow out that debt over the next 30 years, he's desperate to create that illusion.
Right now, US debt is around 120 per cent of GDP, the kind of levels that caused a full-blown debt crisis with Greece and the European Union just over a decade ago.
With Trump's bill, it could grow to between 170 per cent and 190 per cent of GDP by 2054.
Stock markets finished the financial year on a high. Our market delivered returns just shy of 10 per cent, while Wall Street hit records over the weekend.
They've cast aside the chaos caused by Trump's "Liberation Day" tariffs in April, which are about to get second airing, and a war in Iran.
But bond markets remain uneasy, pushing US market interest rates higher, as global investors continue to shift money out of America. The US dollar is now at a three-year low.
Uppermost among the concerns is the independence of the US Federal Reserve and whether it can maintain its role as a responsible agency for monetary policy.
The president, half in jest, pondered aloud a fortnight ago whether he may be able to appoint himself to replace Powell.
Back in April, he canvassed sacking him, but dismissed the idea as bond markets went into revolt over his tariff plans.
Trump now seems convinced that Powell's replacement could be named early and possibly even sit as a "shadow chair" on the Fed board.
Some commentators are concerned that such a move would make Powell a lame-duck chair.
But the greater risk surely would be that the Federal Reserve would be a lame-duck central bank.
For whoever Trump appoints — regardless of their ability or standing — may well be tainted by the perception that they are nothing more than a presidential puppet with a primary focus on securing another election win rather than managing the economy.
Such a move could spark a repeat of April's bond market panic. Back then, investors dumped US government bonds, which pushed US market interest rates sharply higher.
Cutting official US rates could have the opposite reaction, pushing market rates higher as confidence ebbs and perceived US risks rise.
That, in turn, could put serious added strains on America's ability to service its debt.
But the showdown between Powell and Trump goes deeper than debt servicing ability. It goes to the heart of credibility at the world's most powerful financial institution.
That's dangerous territory to be playing in.
This time next week, Michele Bullock and the rate-setting gurus at the Reserve Bank of Australia will settle in for yet another nail-biting decision on where domestic interest rates are headed.
Financial markets have all but signed off on another 0.25 percentage point rate cut to 3.6 per cent.
Economists, who were divided last week, are mostly coming to the same conclusion.
The most recent GDP figures were weak, and inflation is cooling at a faster clip than expected.
While the RBA in the past has been extremely cautious with rate cuts and could easily wait until August — after the June quarter inflation data drops — the weak domestic data and the rising wave of offshore uncertainty is probably enough to tip the balance.
The fallout from a US bond market conniption in reaction to a loss of confidence in the Fed could be severe.
There'd be the inevitable financial markets jolt. But that would feed through to the broader financial system, the complex structure that oils the wheels of business and feeds through to the fragile emotions that determine much of our worldly wellbeing.
Trust, confidence and optimism can quickly evaporate and turn to fear.
Actions and reactions.